Proof that interest-only loans are costing property investors more

Property investors are being urged to start paying down their home loans, thanks to the rising costs of interest-only loans.

A new tool explodes the myth that property investors who choose an interest-only loan are better off than those with a conventional principal-and-interest loan. Borrowers may think they are getting a better deal with an interest-only loan because they are paying less per month and their repayments are 100% tax deductible. But a new UNO investment property home loan calculator, which shows the cost of financing an investment property through an interest-only loan compared with one in which the principal and interest are paid off simultaneously, proves that this is not the case. A traditional loan is much cheaper than an interest-only loan because borrowers pay a lower interest rate and are able to reduce the overall amount they need to pay back straight away. And contrary to hat banks, mortgage brokers or financial advisers might tell them, investors who choose principal-and-interest loans rather than interest-only loans are typically better off from year one. “If your aim is to get a better return on your investment, then anything that diminishes your return is a bad idea,” UNO Home Loans founder and chief innovation officer, Vincent Turner says. “Given that interest-only loans cost more than principal and interest loans, unless you have some other factor – such as a need for cashflow – then choosing an interest-only loan is costing you money.” Need a home loan?UNO. The new way to get a better deal. Get Started

What the calculator measures

UNO’s investment property home loan calculator measures a borrower’s loan amount and their property value, taxable income and rental income. “With these values, we can estimate the total costs if your loan is interest-only versus principal-and-interest based on a rate you’re likely to get from our lenders,” Turner says. “It shows the cost to you by having interest-only versus principal-and-interest.” Although the calculator only measures the difference in savings over a one-year and five-year period, it shows a clear advantage for those paying off the interest and the principal. Even those holding an interest-only loan who are looking to sell their investment property within three to five years suffer in the comparison. “They have even more to lose,” Turner says. “It’s a commonly held belief that ‘investment equals interest only’ in a loan structure. This no longer holds true.” UNO founder Vincent TurnerLet’s take, for example, Tom, who earns $118,000 per year. He is looking to borrow $544,000 to buy an investment property worth $680,000, from which he is hoping to get $300 a week in rent. Using UNO’s calculator, he is able to compare the merits of going for an interest-only loan, at a rate of 4.3 per cent, against a principal-and-interest loan at 3.9 per cent.

If he chooses interest-only:

  • Tom would gain an additional $916 tax benefit by going interest-only
  • He’d also enjoy a lower monthly mortgage repayment
  • However, over the first year he would pay an extra $2349 in interest.

If he chooses principal and interest:

  • Tom would slash $9748 from his investment property home loan balance in the first year alone.
  • This means the net benefit of Tom choosing a principal and interest loan over an interest-only loan is $3778 
 and that’s just in year one.
  • Over five years, the benefit of Tom choosing a principal and interest loan is $25,373

Calculate what you could save

If you have an investment property, you can compare the costs of an interest-only loan with a principal and interest loan below. This calculator assumes that the interest components of your home loan repayments are tax-deductible. There may be other expenses that can be tax deductible too – such as property management fees, or depreciation.

The interest-only myth

Banks, accountants and brokers have recommended investors use interest-only loans for years. Aside from being able to claim a tax benefit for the interest component of a loan (which is higher for interest-only loans), borrowers with an interest-only loan pay a lower total mortgage repayment each month than principal and interest borrowers. The theory is that they can put the money they would otherwise put towards their mortgage on servicing other debts or investments. This potentially made sense when the price of interest-only and principal and interest loans were comparable. But it has always been risky for investors to take out a loan that doesn’t require them to pay off the principal, even for a limited number of years. As investors with these loans pay back just the interest component, they might be encouraged to borrow more than they can truly afford. This reality often hits home only once the interest-only period ends. Investors who take out interest-only loans also rely on strong rental growth and rising property values, rather than reducing their debt levels. This is a dangerous strategy when real estate markets go sideways, or even backwards.

Regulators act on interest-only loans

The Australian Securities and Investments Commission (ASIC) reports that about 60 to 70 per cent of investor loans are interest only; even about 25 to 30 per cent of owner-occupiers have interest-only loans (source: ASIC survey of 11 lenders, 2015). The chairman of the Australian Prudential Regulation Authority (APRA), Wayne Byres, says two in five residential mortgage loans in Australia are interest only (source: APRA). Indeed, the recent growth in interest-only mortgages for Australian investors and owner-occupiers has been astonishing. Total interest-only borrowings rose from $88.7 billion in 2012 to $153.8 billion in 2015, with the average interest-only loan at $430,000 (source: APRA). Such uncapped growth led to ASIC and APRA moving in April to limit the number of interest-only loans to 30 per cent of total new residential mortgage lending. APRA also placed internal limits and more scrutiny on lending institutions that offer interest-only loans. As a result of this regulatory intervention, lenders have increased the interest rates on their interest-only loans by as much as 0.7 percentage points compared with their principal-and-interest offers. It’s this change that’s busted the interest-only myth: Now that interest-only loans more expensive, it likely no longer makes sense for property investors to choose them.

Stop ‘burning money’

Turner says rising rates and the restrictions on interest-only loans only reinforce the need for investors to choose principal-and-interest mortgages, which allow borrowers to pay off their debt faster and are better value overall. “We had a few customers come in who were looking at refinancing their interest-only loan because their lender had moved their rates up,” he says. “So we asked the question ‘Should you even be on interest only at all?’” What does he say to those who are still on an interest-only investment loan? “Unless you have major cashflow issues, you’re literally burning money. Stop doing that, and start getting the advice and service you deserve as a property investor. “If your current lender or broker hasn’t already reached out to tell you that you could be saving money by switching to a principal and interest loan, you have to ask whether they’re the right provider to help support your financial outcome moving forward.”

What to do next

Property investors have two options to get started in optimising their financial outcome.

  • Find a deal by searching our best principal and interest home loan rates
  • Book in a quick call with a UNO mortgage advisor It’s important to note that the information we give here is general in nature – no matter how helpful or relatable you find our articles. Even if it seems like we’re writing about you_, it’s not personal or financial advice. That’s why you should always ask a professional before making any life-changing decisions._ Book a call in with UNO

Book Call Now

UNO home loans

Need help with your home loan?

UNO Brokers are available night and day for a quick review or your situation and bring expertise that will support better decision making that will save you time and money. Book in a quick call when it suits your busy schedule

Get Started
Try Plans, by UNO
Mortgage calculators completely reimagined
Get Started

Related Articles

TESTIMONIALS

What our customers are saying

Kyle Richards
October 10, 2024
Absolute legend, helped me through the first home buyers scheme, explained everything in a way that made sense, was very knowledgeable and a joy to work with.
Read more
Chloe S
October 8, 2024
Mike Parsons made it possible for us and the in laws to get 2 pretty complicated home loans. He helped us through everything and we'd be happy to use Mike and the team again for anything we needed. Thanks again!
Read more
Sam Rezai
October 2, 2024
I have gone through 6 different mortgage brokers prior to meeting Andrew Wyers. He is the most patient mortgage broker I’ve encountered and also the most knowledgable about the bank’s lending process and products available. It took me 1 year to find a house I was happy with and Andrew was always there to assist with any issues or questions I had; he always return my phone call, even on the weekends or when his away on holidays. The loan process was smooth and I had no complications. The process with Andrew was again nice and easy, he took the time to find and put together the right package that was suited to my situation. I have recommended Andrew to my family & friends and everyone have been grateful and completely satisfied with his service.
Read more
S Wilko
September 23, 2024
I had not dealt with Scott or UNO before finding them on the internet. Even as an Australian citizen living and working overseas, I knew obtaining a loan would be difficult. However, Scott went above and beyond what I expected from a mortgage broker. I genuinely don’t think you could find another company that works as hard as they did to get my home loan approved. I cannot recommend them highly enough. Everyone I dealt with at UNO were extremely professional and helpful. If you are looking for a broker, you would be mad not to give them a go. Thanks to Scott Wilkinson, Dalby Bajwa, Jena Lasquite and Andrew Pacini. Shaun.
Read more
Shan Liao
September 3, 2024
I had an outstanding experience with Tian Liu. He was incredibly professional and attentive, going above and beyond to meet my needs. His expertise and dedication made the entire process smooth and stress-free. Tian's deep knowledge of the market and commitment to finding the best solutions for his clients truly sets him apart. He was always available to answer my questions and provided invaluable guidance throughout. I highly recommend Tian Liu to anyone in need of a reliable and skilled broker!"
Read more
Nathanael Chin
September 3, 2024
Tian Liu provided exceptional service throughout the entire process. His professionalism and keen attention to detail were evident from the start. Tian consistently kept us informed and offered insightful advice that made us feel confident in our decisions. He truly cares about his clients and works tirelessly to ensure the best possible outcome. We couldn't be happier with his assistance and highly recommend Tian to anyone looking for a trustworthy and knowledgeable broker.
Read more
Patrick Winters
August 14, 2024
For the past three years, it has been an absolute pleasure to work with Mike Parsons. He has consistently helped us navigate commercial property loans with skill and efficiency. Mike’s timely and professional responses to our inquiries have been invaluable. We have built a strong, reliable relationship with him and eagerly anticipate continuing our collaboration in the future. We highly recommend his services.
Read more
Lee Robibaro
August 6, 2024
I am so thankful and grateful to have Scott Wilkinson as my broker. He not only looked after me every step from start to finish he gave me confidence and I was able to trust him and his expertise. My children and I are now happy in our new home and very appreciative of Scott's help. I will definitely be only having Scott as my broker from here onward as there is no mucking around and straightforward answers. Thanks again
Read more
Steve Mav
August 6, 2024
Scott and the whole team at uno have been amazing. Super responsive and helped us achieve a result that we couldn’t have possibly achieved on our own.
Read more
Thien Pham
August 5, 2024
Scott, Dalby and Jena were awesome to work with for my recent Home Loan, they are responsive and knowledgeable - which helped ensure a smooth purchase from pre-approvals to settlement. This is the second property I've purchased with UNO as my mortgage broker and would definitely recommend their services. Thanks again to the UNO Team for the awesome support.
Read more
Scott Hutchinson
August 5, 2024
I am writing this summary in support of recommending Mike Parsons as a Mortgage Broker. At the time of writing this, I have known Mike for 4 years and he has executed 4 mortgages deals for me (including 2 refinances) over that time. Mike has provided me incredible service as a mortgage broker as follows : - Works painstakingly on getting the scenarios together to provide you options that optimize your position. - Works inordinate hours on the detail necessary to support the scenarios. - Mike keeps you updated on the status and progress of the applications and also helps you work through answering questions and any complexities that may arise. -In my cases, given the complexities and timings of my situations , these application processes would take many weeks to finalize . Mike never gave anything other than utter commitment and focus to getting the job done. Mike acts as a true business partner throughout this whole broker /mortgage journey. I simply would only go to Mike for any future dealings on getting a loan from a bank (and as will my kids in the future !) . There is no way a bank (I have seen anyway) would provide this kind of time nor service to a customer. You can rest assured that once Mike has done the deal, you have ended up with the most optimized position taking into account all the variables/scenarios in play. Scott Hutchinson
Read more
Jason Seam
August 5, 2024
I've worked with Scott Wilkinson for my last 2 properties and he's been excellent. He sourced multiple options and didn't push a specific bank, tailoring his recommendations to me based on my requirements. I was specifically requesting a "medico loan" and Scott could navigate that extra requirement with expertise. When I was initially working with Scott, I was also trialling 2 other brokers and neither of those 2 had the same breadth of lenders, or could provide the same deals. I've referred multiple buyers to Scott and his team; one of them said to me after working with him, "how'd you find this guy, he's so good compared to all the other broker's I've worked with!" I'm going into my next purchase with Scott as my broker partner again. I recommend him to everyone
Read more

Try Plans by UNO

Mortgage calculators completely reimagined
Get Started