If You Choose Principle & Interest Repayments It May Be Negatively Geared. Don’t Panic! This Is Ok.

Dilleen Property Group 2021

Principal and Interest or Interest only?

On a daily basis clients ask me “should I do principal and interest loan repayments?”, “should I do interest only repayments?”, and “what are the repercussions of each?”. This blog post aims to discuss all these points, and help you make an educated decision. However, in saying this, there is no right or wrong answer.

Using a Cash Flow Spreadsheet

When analysing an investment property, I recommend everyone should use a cash flow spreadsheet. Cash flow spreadsheets allow you to physically see all the expenditure such as council rates, water rates, management fees, insurance, strata (if applicable) or building insurance if it's a house, and maintenance repairs. You should also look at your income. This can be done per week, per month, or per year.

Negative gearing on Principal and Interest?

I was speaking to a few clients who had been analysing their cash flow for their investment property, and when they factored in the principal and interest component, compared to interest only in terms of cash flow pre-tax, before tax deductions, and before depreciation, they found that it was a slightly negatively geared on principle and interest components. It was negatively geared by $15 a week, which wasn't a big deal. However, on interest only it would have been positive geared by roughly $50-$60 a week. Whether you structure your investment property repayments on principle and interest, or interest only, it will have an impact on cash flow in the beginning.

The reason why some investors select interest only repayments in the beginning of building their property portfolio, is because it allows them to have a higher cash flow coming in. They can then hold that cash in their bank account to use as a maintenance repair buffer or to build up another deposit.

Eddie’s Personal Experience

When purchasing my first, second, and third investment properties, I chose to repay the loan on principle and interest because I had that old-school mentality where I thought debt was bad and I wanted to pay it off as soon as possible. However, If I was to start again I would actually put majority of my first investment properties on interest only, because it allows me to conserve more cash and have that cash flow to then deploy into another investment property.

Ultimately, I believe when choosing to do interest only repayments this will depend on your age. . If someone's starting out and they are in their mid-20s or in their mid-30s, they still have time to do interest only for the first 2-3 years. Yes, the loan isn't decreasing for the first 2-3 years, but it's a means to an end. You are accumulating more cash flow to buy more property quicker in the short-term, which is ultimately going to lead to more money after 5-10 years.

For Example

As an example, if your loan is on principle and interest repayments, and you're able to buy 3 properties over the next five years, those 3 properties over the next 15 years will double in value. This is just one scenario. However, if you're able to do interest only for the first 2-3 years to boost up your cash flow, then you will be able to generate more deposits to put into 5-6 properties, as opposed to only 3. Those 5 or 6 properties will double over 15 years and you're going to have double the amount of equity in the next 10-15 years.

I like to look at the long-term and the short-term sacrifices to make. Yes, in the first 2-3 years your loans won’t be decreasing, but it's about trying to take the emotion out of it and look at the long-term effects. You need to take the necessary steps to achieve your end goal of building a portfolio that's going to provide a financial freedom.

Disclaimer: This is not intended as legal, financial, or investment advice and should not be construed or relied on as such. Before making any commitment of a legal or financial nature, you should seek advice from a qualified and registered legal practitioner or financial or investment adviser.