A question we’re always asked is “should I be paying interest only or principal and interest on my loans?”
BY JAMIE MOORE
When it comes to claiming an investment loan as a deduction – only the interest portion of the loan is tax deductible, the principal portion is not.
Therefore, if you have an investment loan and you decide to pay down the principal, you’re effectively reducing this tax-deductible debt. This can be a costly mistake for those who also have non-deductible debt such as a home loan on your principal place of residence (PPOR), personal loans or credit cards. If you want to pay down debt, it’s this non-deductible debt that you should try and knock on the head first.
So what’s the ideal structure? Generally speaking, it’s ideal to have all of your investment loans set up as interest only. With your PPOR debt, if you feel that your PPOR will one day turn into an investment property and you’re a disciplined saver, then you may benefit by setting this loan up as interest only. Why should my PPOR loan be set up as interest only if I think it’s going to become an investment property down the track? Because this debt will become deductible in the future – so you shouldn’t reduce it now.
However, you might want to set up an offset account against this loan so you can continue to make the equivalent principal repayments regularly into the offset account – or use it as a place to park your savings. When this property becomes an investment in the future, you can move the funds from your offset account onto your next PPOR. This way, you’ve increased your tax-deductible debt and reduced your non tax-deductible debt.
The interest only with an offset structure doesn’t work well for someone who isn’t a disciplined saver and will be tempted to simply make the minimum interest repayments. If this sounds like you and you have no desire to convert your PPOR into an investment property at some point, then it might be best to have a principal and interest loan on your PPOR.
So in a nutshell, interest only for all loans with an offset account set up against your PPOR loan can be a great overall structure – particularly if you think you might turn your PPOR into an investment property at some point. On the flipside, if you have no desire to turn your PPOR into an investment property and you’re not disciplined with money, then principal and interest against your PPOR with interest only against all investment loans would be more ideal.
This information is of a general nature – please always consult taxation professionals about the specific nature of your situation.
Jamie Moore is the owner of Pass Go Home Loans, a mortgage broker firm specialising in sourcing and correctly structuring finances for property investors across the country. www.passgo.com.au
