Welcome back to Prosperity Finance.

In the last article, we discussed when we should pay interest only on our loans. Our discussion today will go the other way, and we will discuss the appropriate time to pay principal and interest.

The following five points are provided for those who use principal and interest repayments more effectively.

1. It's better to pay principal and interest on your owner-occupied property.

There are two reasons for this. Protecting your family home should be one of your top priorities. To protect our assets, the sooner we can repay the mortgage, the sooner we can get it discharged from the bank. Furthermore, interest on family homes can’t be used as tax-deductible expenses. Therefore, we have no real advantage there.

2. It's better to pay principal and interest on properties that do not help you deduct taxes or will not be able to deduct taxes soon.

We have already discussed the tax issue in the first point. Under the current government policy, for any property purchased after the 27th of March 21, the interest cost cannot be tax deducted as an expense unless it’s a new build property or you rent it to Housing NZ. It is preferable to choose principal and interest repayment when you have a property that does not qualify for a tax deduction. We can continue to pay interest only on properties that are tax-deductible and principal and interest on properties that are not tax-deductible.

Furthermore, this also applies to properties purchased before March 27, 21. Even though these properties will be tax deductible until 2025, the amount of tax deduction will decrease each year and will no longer be deductible in 2025 under the current policy. If you no longer have a mortgage on your home, we recommend you start paying down the principal balance of these properties. This way, if you cannot continue deducting your taxes after 2025, you will have a smaller debt to repay.

3. consider paying off the smaller loan with principal and interest first.

If you have already paid off your family home and all your rental properties have the same tax implication, you may want to consider paying off the smaller loan first. As soon as you have paid off the loan, you can discharge the security. In this way, you will be able to protect your assets further, as the bank does not control them.

4. Those who need to maximise their borrowing capacity should choose a principal plus interest loan.

Now, if you want an interest-only loan, your borrowing capacity will be reduced.

Maximising loan amounts and having an interest-only loan are two conflicting priorities. As we all know, New Zealand has a maximum loan term of 30 years. When you have five years of interest-only payments, you only have 25 years to pay principal and interest. Using the same income, you could borrow less if you had 25 years to pay principal and interest than if you have 30 years loan term. As a result, the longer the interest-only term, the less loan you can borrow. Typically, if you want to maximise your loan amount, you will need to reduce your interest-only term or even give up an interest-only mortgage.

Cashflow needs to be balanced as well. Unless you plan to purchase a tax-deductible investment property, such as a new build, you do not want to have all your loans on principal and interest. Otherwise, it won’t be easy to manage your cash flow. With the current interest rate, you are unlikely to cover the financing costs and other associated costs, such as insurance, maintenance, etc. Therefore, you may need to contribute more cash from your pocket.

Finally, you may not qualify for an interest-only extension if you have an interest-only loan and it is about to end its interest-only term.

As we mentioned in the last article, when you want to extend your interest-only loan, you need to submit a full application, just like how you apply for a new loan. In the current lending environment situation, many people find they are no longer qualify for the servicing requirement of their existing loans term, so they may be forced to repay principal and interest.

Hopefully, you will find these five points helpful when considering your loan structure, or at least be aware of them. As you can see in the last article, we discussed the advantages of interest-only loans. In addition, we discuss when to pay principal and interest, so it's not a black-and-white choice. The answer depends on your situation and your goals. Therefore, if you want to know what is best for you, we suggest contacting us so that we can tailor a solution to meet your specific requirements.

 Disclaimer: The content in this article are provided for general situation purpose only. To the extent that any such information, opinions, views and recommendations constitute advice, they do not take into account any person’s particular financial situation or goals and, accordingly, do not constitute personalised financial advice. We therefore recommend that you seek advice from your adviser before taking any action.