Does increased cash flow justify the interest expenses?
It’s usually best to pay off your home loan as quickly as possible by making principal and interest (P&I) repayments but this may not always be of most benefit if you’re a property investor.
Luckily, the interest only vs principal and interest calculator can give you a pretty good idea of your repayment choice and its impact on your expenses, cash flow and return on investment over the life of your mortgage.
IO vs P&I calculator
Disclaimer:This calculator has several assumptions and simplifications and so should be used as a guide only. Please seek independent financial advice and your own circumstances before making any decisions about your home loan repayments. Making interest only repayments can significantly increase the cost of your mortgage over the term and expose you to higher repayments at the end of the interest only term
By trying the interest only or principal and interest calculator, you can make a more informed decision on whether it’s worth wearing the interest expenses over the long term in order to free up cash flow to buy more properties or invest elsewhere.
How does this calculator work?
By entering in a few simple details, the IO or P&I calculator works out:
- Your total yearly mortgage repayments under principal and interest (P&I) compared to an interest only loan.*
- Your interest only cash flow benefits.
- Your interest expenses under IO.
- How much higher your tax refund will be under interest only.
- Your after tax P&I expenses compared to IO.
- Your effective return on investment (ROI).
*The interest only calculations are based on a 5-year term that then switches to P&I for 25 years (30 year home loan term in total).
While our calculator will give you a detailed breakdown between principal and interest versus interest-only, investors should consider their borrowing power, their intention to buy more properties or to pay less interest when deciding.
Interest only versus principal and interest case study
Sam wants to buy an investment property worth $500,000 and he can contribute $90,000 to the purchase bringing his Loan to Value Ratio (LVR) 82%.
Sam is almost certain he wants to go for principal and interest repayments so he can pay off the home loan as quickly as possible.
However, with plans to invest in real estate in the next two years, he’s not sure how much potential cash flow he would be missing out on by not choosing a 5-year interest only term.
Crunching the numbers
After speaking with his mortgage broker, Sam discovers that he qualifies for a 3.64% per annum interest rate by choosing principal and interest repayments.
With an interest only loan (5 year term), this climbs to 4.24% p.a..
He currently earns a gross yearly income of $85,000 making his tax rate 21.9% (as of 2018).
Inputting these figures into the interest only vs principal and interest calculator, Sam works out that he’d have at least $5,633.98 (after tax) in extra cash flow over 30 years.
However, he would be $1,921.26 worse off in interest expenses (after receiving around $538.74 as a tax refund).
Over the 30-year life of the loan (5 years IO and 25 years P&I), Sam’s total principal and interest cost would be $264,377.20 compared to $301,961 paying interest only for the first 5 years.
If he chose P&I over interest only, that would mean a saving of $37,583.80 over the life of the home loan and an effective return on investment (ROI) of 48.28%.
After using the negative gearing calculator and getting advice from his financial adviser, Sam decides that he’s happy to wear the interest expenses and choose an interest only loan term.
That’s because by year 5, his property will be positively geared.
Read about managing cash flow when negative gearing.
Don’t know whether to choose interest only or P&I?
Choosing an interest only mortgage over a P&I home loan is not just a matter of being a property investor versus being a homeowner.
There are pros and cons to each repayment type that can have a long-term effect on your overall investment strategy.
We can properly assess your situation and let you know which option best suits your long-term goals.
Speak with one of our interest only loan specialists on 1300 889 743 or by completing our online enquiry form today.