P&I or Interest Only?

15/06/2018

Recent regulation capping Interest Only lending has been successful.

Lending growth has moderated, standards have been lifted and oversight has arguably improved.

Data from the banking and insurance regulator, Australian Prudential Regulation Authority (APRA), shows interest only loans currently represent less than 20% of new mortgage lending. This compares with close to 40% in the comparison period last year.

We have seen interest rates on Principal & Interest lending fall (both for investment, business and personal purposes) and we see this as a more permanent positioning.  Financial institutions will become increasingly stringent on justifying reasons for interest only loan repayments.

So what does this mean for you?

PRINCIPAL & INTEREST REPAYMENTS (P&I)

For many it will mean greater cash outflow, as the loan will “amortise” from the outset.
Though it is not all bad news, interest rates on P&I repayments will become increasingly lower than interest only loans.

Consider the following example on a $500,000 loan:

At 5.0% Interest Only – Repayments are $2,083 per month.
At 5.0% P&I – Repayments would be $2,684 per month.

This is a substantial increase to cash outflow but it does build some equity in this asset too.

Now add in benefits of a reduced interest rate of 4.00%.

At 4.00% P&I repayments would be $2,387 per month.

This is only a small premium above the interest only rate.

YOUR OPPORTUNITY COST

For business or investors, those in the position to choose between interest only and P&I must consider their opportunity cost.  This is especially true in a low interest cost environment.

So, in the example above, is it better to invest the additional $304 per month into the debt, or can you get a better return by conserving this cashflow and putting it work elsewhere? 

Seek advice of course, but it should not be a strategy that is dismissed, consider why you actually need interest only repayments. 

It is a great opportunity to litmus test your overall investment return.