Choosing the right Finance structure for your property investment
People invest in property to achieve various financial goals, including supplementing retirement funds or covering the costs of children’s education. One thing all investors should have in common is a strategic financial plan to ensure their assets are working to the best of their ability. Good financial management of an asset will provide tax breaks, increase cash flow, and minimise unnecessary expenses or fees.
One of the major considerations for meeting your financial goals is how you structure your finance. It is important to understand the options available to you, as every investor has a different profile and set of objectives.
Principal and Interest Loans
In a principal and interest (P+I) loan scenario, a property owner is paying both the principal and interest off simultaneously. Principal refers to the amount borrowed from the bank, and interest is the bank charges associated with borrowing these funds. In many cases, this loan structure comes with a fixed term which means the repayments are set up over a predetermined timeframe.
The benefit of a principal and interest loan is that the interest and value of your loan decreases over time until which time the loan is completely paid off and the asset is owned outright by the investor.
Source: ANZ, 2016: http://www.anz.co.nz/personal/home-loans-mortgages/manage-existing-mortgage/home-loan-repayment-types/
Interest Only Loans
An interest only (IO) loan is when an owner is only paying the interest amount to the bank, and making no contributions to the principal amount. IO loans are beneficial for investors who wish to increase their cash flow as the monthly repayments are significantly lower than a P+I loan. Many investors also choose IO loans to maximise tax deductions as the interest on an investment property is completely tax deductible.
It is common for investors to use the money that may be spent paying off the principle to reinvest or use elsewhere within their portfolio. This is also a good option if your plan is to sell the asset in the short to medium term.
Source: ANZ, 2016: http://www.anz.co.nz/personal/home-loans-mortgages/manage-existing-mortgage/home-loan-repayment-types/
Variable Loan Structure
A variable loan is the most common way people structure their loans for their own homes. As it is variable in name and nature, this loan structure exposes you to fluctuating interest rates. On one hand it is great if the interest rates go down, but can put pressure on your cash flow should they increase.
Fixed Loan Structure
A fixed loan allows you to lock into a fixed rate from one to five years, which means repayments are never subject to change during this period, despite what happens with interest rates. A fixed loan is great for the budget conscious and anyone who doesn’t want to risk their potential cash flow. The important thing is to time a fixed loan appropriately so as to not be locked in on a high interest rate.
Source: MortgageChoice, 2016: https://www.mortgagechoice.com.au/home-loans/home-loan-types/fixed-vs-variable-home-loans.aspx
Generally speaking, a fixed loan will not allow you the flexibility to pay off your mortgage quicker if you wish, unlike the variable option.
Seek professional advice
It is important to speak to your mortgage broker about your options to ensure you have a financial structure which works for you. The right loan structure can save you time and money, minimise tax, optimise your investment property’s cash flow and reduce your home loan expenses.
To discuss how to structure your next loan, please contact us.
