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If your principal place of residence (PPOR) is your forever home, then Principal and Interest repayments is a good option. However, if you intend to make your PPOR an investment property down the track, and buy another home, it is beneficial to have an Interest Only term, along with you maintaining an offset account.

The effect of making Interest Only payments, and parking the additional funds (which would have otherwise been principal repayments) in the offset account is that you maintain ‘control’ of the funds. Additionally, this has a similar effect in terms of interest calculated on the balance as where you would have made Principal and Interest repayments.

When you convert your home to an investment property, you can withdraw funds from the offset account, such that the loan balance stays the same as the original balance, therefore maintaining tax deductibility.

Option 1 – Principal and Interest:

You have PPOR debt of $400,000, at 4.2%, and assuming 30 years term, your Principal and Interest Repayment will be c. $2,000 per month, which includes interest of c. $1,400 ie Principal repayment of $600 per month (note – the proportion of principal and interest repayment will change over the course of the loan term). As the repayments progress, the principal balance of $400,000 will reduce.

Say in 5 years, you have paid $40,000 of the principal balance, bringing the loan balance to $360,000.

Converting this property into an investment property at that time will mean that your tax deductible loan will be $360,000.

Option 2 – Interest Only

On the other hand if you make Interest only payments, you will have a $400,000 loan balance, with an offset account attached to this loan. You will make $1,400 per month in interest repayments, and park the $600 per month in the offset account (note – as the offset account builds up, the interest repayments will reduce). The interest will be calculated on the loan balance minus the offset account balance. Assume over 5 years, you park $40,000 in the offset account.

If you decide to make this property an investment property, you can withdraw the $40,000 from the offset account, which will bring back the loan balance to $400,000. This will maintain the tax deductibility of the loan.

Conclusion

There are pros and cons of both approaches.

Where you wish to buy another PPOR, under Option 1, you will either need to borrow the $40,000 back from the bank or sell the property to get access to cash. Where you borrow the $40,000 back from from the bank, this will be a non-deductible loan.

Interest only payments is a great option where the property is not your forever home, as it allows you to maintain tax deductibility of the loan. However, with interest only, it is good to be disciplined with building up your offset account balance.

Any questions or if you need direction – leave your contact details in the comments below or email the Property Twins at [email protected]

Note: This article is valid at the time of writing. Evolving lending climates may mean this strategy may no longer apply


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3 thoughts on “Principal & Interest (P&I) vs Interest Only (IO) Payments Toward Your Home. What’s the verdict?”
  1. Ranee Mackson

    Hi, with say 100k in an offset account are the monthly mortgage repayments based on mortgage of $400k or $300k? And Can u only notice it at the end of the tax year?

    • admin

      Hi Ranee,

      If you have 100k in the offset account and the loan is 400k, interest will only be charged on the 300k. You can reap the offset benefits as you go and don’t need to wait for tax time.

      Cheers
      Property Twins

  2. Gautam kulkarni

    Hi,
    Can you increase the loan for PPOR to say 600k – assuming its the value and claim interest on 600k in tax if PPOR becomes investment?
    Thanks.
    Gautam

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