Hi,
I am looking into buying an investment property. My question is can someone please explain why it is better to pay off the interest on your loan and not make extra payments to the loan?
Your advice is appreciated!
Thanks
KathyHello Kathy
Basically if you use a IO loan and put your spare cash into a 100% offset account coupled to this loan you achieve the same interest reductions but keep your options open.
Obviouly if you have a PPOR ( non tax deductible interest) you should have this offset account coupled to your PPOR loan.
Here is a link to a thread that also discusses this question.
https://www.propertyinvesting.com/forums/getting-technical/finance/4324661
Hope this helps
ElkaAlso if you pay interest only you may be trying to increase your cash flow for some other investment or other reason.
If you are paying off the loan the repayment is higher where as on a interest only loan will be a bit lower in repayment.From a taxation view point – making repayments of principal reduces the interest charge and on an income producing asset this will increase the assessable taxable income as the interest charged slowly goes down over time.
However with the new tax marginal rates the tax deduction available on negative income is a lot less than it use to be.
So you may pay for example say $10,000 in expenses but claim say 30% on your marginal tax rate then you get $3000 back but spend $10,000. This is really a $7000 loss rather than a real tax windfall .I tend to like the idea of reducing the principal amount as it allows you to grow equity over time which you can borrow against later on. You may pay tax on the income but the point is it is income rather than a loss.
I agree with you about growing equity over time duckster and use my offset accounts in the same way as if I was putting it directly into the loan i.e. this is not spending money unless it's for another investment..
Of cause you need to be very disciplined financially otherwise you are better off putting it into the loan so you won't spend it on lifestyle.
A big advantage of having funds in an offset account is that it can also function as your emergency money.
If you loose your job, or all your tenants at the same time, or the interest rate rises start to bite you can use this money to continue servicing your loans till the problem is resolved.An effective way of maximising your cashflow is to use facilities such as Offset accounts ect, but as mentioned below you will have to be good with your money.
You would basically use interest only if you want to have room in your budget to service another property perhaps.
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