Opting for an interest-only loan has always been a sound strategy for investors, with the tax benefits associated with negative gearing, maximising cash flow and directing funds available to pay down owner-occupied debt. These are still very compelling reasons to remain on an interest-only investment product, but as the banking goal posts have moved in recent years, many are choosing to think outside the lending box and look at paying principal on their investment loans. And here’s why.

Principal and interest loans are cheaper than interest only

Previously, the investment loan rates were much simpler to navigate – they were either fixed or they were variable. Now, pricing is also determined by whether or not principal is being paid, with principal and interest (P&I) products generally being cheaper.

Investors are now faced with deciding if paying principal is the right strategy for them. A compelling argument is that you will be “investing” extra funds through increased repayments, the net result being debt reduction and hence wealth creation.

Consider this:

For a $400,000 investment loan at 4.99% interest only, the monthly repayment is $1,663. If the same loan is reverted to P&I at 4.14% the repayment is $1,976 but the interest component of that is only $1,380, meaning $596 is being paid off the principal. Given that the overall repayment amount has increased by only around $312 per month the net result is that you will be “making” $284 per month. What this equates to is that over the course of a year a total of $7,152 will be shaved off the amount owing by simply increasing the repayments by $3,744.

Who should consider a P&I investment loan?

Those with low or no owner-occupied debt

For those without an owner-occupied loan, or may have their debt fully offset or very little of it, it may be worthwhile considering paying down investment debt that may be held. After any high interest debts such as personal loans and credit cards are cleared, tackling your investment loans head on could be a worthwhile consideration.

Those with high disposable income

If you are at a time in your working life when you are on a comfortable wage and have a high disposable income, no matter your age, it’s never too early to get your financial ducks in a row for retirement. Part of that involves managing debts, so it stands to reason that while funds allow, it could be beneficial to pay down your investment debt so it does not prevent you from retiring as early as you would like or so it does not hinder your cash flow at retirement.

For simple wealth creation

It’s painfully obvious but paying off any debt against a property is going to lead to wealth creation, which is usually the reason an investor purchases real estate in the first place. This is often the simplest way to create equity in a property particularly when property markets are flat.