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Interest only loans

Discussion in 'Finance & Banking' started by nitro-nige, 25th Sep, 2007.

  1. nitro-nige

    nitro-nige Well-Known Member

    8th Mar, 2007
    Reservoir, Melb

    I have a beginners question about interest only loans.
    Is the general idea to consider the interest on a loan as an expense to use someone else's money, kinda like rent? Or do you aim to have enough capital gain/ return on investment to pay off the loan?

    Or is there another train of thought?

    Cheers Nige.
  2. Simon Hampel

    Simon Hampel Co-founder Staff Member

    9th Jun, 2005
    Sydney, Australia
    The general idea is to use inflation to reduce the real value of your loan over time.

    Because inflation erodes the value of money over time, a loan of $100K today is worth subtantially less than this (in real terms) in 20 or 30 years time - so you need less money (relatively speaking) to pay it back in the future.

    The trick is that you do pay for the use of that money over time, your average returns need to be larger than your interest cost on the loan plus inflation on the capital you have invested, otherwise you are effectively going backwards.

    You don't ever actually need to pay back the loan - you can just keep refinancing or rolling it over to a new IO loan.

    It depends on your strategy as to whether you want to pay off the loans - if you have a set goal in mind for your asset base, then once you reach it, paying down debt with surplus income will help consolidate your position.

    However, if you intend to keep acquiring assets and leveraging to do so, there's no point paying back (investment) loans now when you're just going to borrow more again soon afterwards!

    Of course, if you have non-deductible and non-productive debt (eg car / personal / credit card loans), these should be paid off as soon as possible.

    PPOR loans are another matter, while interest costs are not deductible, it may well be a "productive" debt in that your property should grow in value over time. You could use debt-recycling to turn your non-deductible debt into deductible debt, or alternatively, if you intend to move out and turn your PPOR into an IP at some point, you want to minimise how much you pay off now to maximise your deductible interest in the future !! It all depends on your circumstances and goals.