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interest only or principle and interest loan.

Discussion in 'Real Estate' started by Jayc, 22nd May, 2012.

  1. Jayc

    Jayc Member

    Joined:
    27th Feb, 2012
    Posts:
    10
    Location:
    Melbourne
    Hi,

    I would like to know what is the advantage of having interest only or principle and interest loan.

    What would the tax effects be after minusing depreciation, etc..

    thank you
     
  2. zudjian

    zudjian Member

    Joined:
    25th Nov, 2011
    Posts:
    17
    Location:
    Melbourne, VIC
    Interest only, as the name implies, means that you only are required to pay interest and you will never actually pay down any debt (principle). The advange of structuring a loan in this way is that your cash flow is higher (ie you can direct more money to other expenses or investments).

    Typically, but not always, an interest only loan would benefit investment (or tax deductible) debt as you are preserving the loan size, therefore the tax deductions will be maximised. Often, you will see people pay their investment debt as "interest only" and their non-investment debt (ie family home) as "principle & interest".

    I'm not sure that I understand your second question?? Depreciation on an asset (that provides an income for you) can generally be claimed as a tax deduction - as can the interest on a loan used to purchase that asset. Any principle payments are not tax deductible.
     
  3. Jayc

    Jayc Member

    Joined:
    27th Feb, 2012
    Posts:
    10
    Location:
    Melbourne
    Hi Zudjian,

    Thank you for your reply, it helps. my second question was mainly aiming after minusing the costs, depreciation, what will the tax implications be?

    Thank you
     
  4. Jamie M

    Jamie M Mortgage Broker

    Joined:
    8th Apr, 2012
    Posts:
    6
    Location:
    Canberra
    Hi there

    Zudjian explained it well. I wrote a blog entry for API mag on this subject that explains the situation in a practical manner - hopefully it helps Australian Property Investor :: API Property Blog

    Cheers

    Jamie
     
  5. M.Investigator

    M.Investigator Positive Cashflow Investo

    Joined:
    22nd Aug, 2012
    Posts:
    13
    Location:
    Sydney, NSW
    I agree that interest only can be a great strategy for getting higher cashflow but I think it's nt sustainable in the long term.

    I prefer cashflow investment properties that still give me cashflow even while I use principal and interest loans. The reason is because gradually over the years, I am increasing my equity and increasing my wealth, by virtue of the principal being paid off over time.
     
  6. GregR

    GregR Reid Consultants

    Joined:
    13th Jul, 2009
    Posts:
    273
    Location:
    Berwick Vic
    Jayc,
    As I understand your second question, there is no difference from a tax deductibility view whether you pay P&I or IO. It is only the interest component that is tax deductible, not the principal or capital component of a loan repayment. The real difference is in terms of cash flow, P&I repayments are greater than IO payments.

    In simple terms, the tax implications are:
    Rental Income, less investment expenses which can include interest on investment loans, normal expenses such as insurance, rates and taxes, repairs and maintenance, property manager fees and depreciation and building allowance (if applicable). The net result either adds to or subtracts from your existing income you declare to the ATO.

    There are numerous avenues to obtain what deductions can be claimed. ATO has a 2012 rental property guide that can be downloaded from the ATO website.

    I agree with Matthew that wealth is about assets less debt and long term you want to reduce debt. However when you do that depends on your own goals and where you are in the life cycle of an investor. Early stages you try to preserve cash flow so you can build your portfolio assets, later in the cycle you start paying down debt.
    Greg