5. Principal & Interest Loans vs Interest Only Loans
The banks will have a number of different options for you when you are ready to get your finance. Understanding the difference between Principal and Interest Loans vs Interest Only Loans will help you understand the bank jargon and ensure you make your finance choices with confidence.
Did you know the game of property investing has a set of rules? And guess what? Those rules are owned by the banks. It's super important we know the difference between a principal & interest loan and an interest only loan. Let me go through it with you right now.
When you got your own home, say if you got a $500,000 property and you still got a $400,000 mortgage and if you decide to have a principal & interest loan. So the repayment's going to be 2,500 bucks a month, so here we go Captain Obvious, there's a principal component and an interest component. So did you know there's a quite small ratio of the old principle and interest loan that starts now basically salami slicing the loan off. So you got like 500 bucks a month, goes into salami slicing the loan and the other 2,000 bucks a month goes somewhere. I'm about to let you know where that goes now.
Here's a quick concept for you. Who's heard of the thing rent money is dead money. Well guess what? You know everyone's like, "Yeah I've heard of that before." 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 the banking. It' basically like 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 bucks 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.
Here's an interesting concept. Some of you might have heard about, what if I pay an extra 100 bucks extra off my home loan every month. What that's gonna do is basically bring your home loan down quicker and you're gonna now inject some redraw funds into your loan 'cause you have effectively paying it off a little bit quicker. In summary, what that all means though from a principle and interest loans perspective. You can here, principle in the blue. Interest in the red. In 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, you know there's almost like 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.