Understanding the difference between Principal and Interest Loans vs Interest Only Loans will help you understand the bank jargon and ensure you make your financial choices with confidence!

How Do Principle & Interest Loans Work?

When you’ve got your own home, say if you got a $500,000 property, you’ve still got a $400,000 mortgage and you decide upon a principal & interest loan.

The repayment’s are going to be $2,500 a month, so here we go Captain Obvious, there’s a principal component and an interest component. Did you know there’s quite a small ratio of the old principle and interest loan that starts now basically salami-slicing the loan off. 

So you got $500 a month, going into salami-slicing the loan and the other $2,000 a month goes elsewhere. (I’m about to let you know where that goes now.

Who’s heard of the saying: rent money is dead money? 

Guess what? When you’ve got an interest component on your principle and interest loan that is also dead money. It just goes into the big black hole of banking. It’s basically the same as you paying rent to the banks for the privilege of you having your home loan – as time goes by though. Basically, the ratio is changed. So as you continue to pay off more and more of your home loan, your $2,500  a month which pretty much stays constant, you’re basically paying more principle and less interest so you do start to pay off your home loan a little bit quicker.

What if I pay an extra $100 extra off my home loan every month? What that’s going to do? Basically, it will bring your home loan down quicker and you’re gonna now inject some redraw funds into your loan because you have effectively paying it off a little bit quicker. 

In summary, what that all means though from a principle and interest loans perspective is that the first one to five years and the first six to 10 years as well, it’s mainly all interest. You’re actually not salami slicing your loan off very much at all. You can see clearly the loan starts to get paid off quite quickly towards the end.

So what does that mean from a generic estimation perspective? Between the tenant, between the taxman and between yourself, there’s a healthy little ration about who’s paying the mortgage.

Conversely, if we choose to go and do an interest-only loan whereby the first payment is the same as what the last payment is, you’re not trying to salami slice the loan off yourself. You’re just putting the right holding strategy in place and what is that holding strategy mean? Between the tenant and the taxman with no input from you, you’re able to have that property sitting in the right market.

Get your mindset right. Make sure you got a healthy combination between rent and tax. All you’re trying to do is buy time here so you can have that property in 10 years time.