An interest-only home loan is designed for the borrower to pay the interest charged on the loan for a set period, not the amount borrowed. The borrower won’t repay the principal until the term ends. Compared with another way of loan repayment (paying principal and interest), going interest-only helps reduce the monthly payments, and it also brings other advantages.

Many investors look to utilise interest-only loan on their investment properties. However, it’s also common to see people pay principal and interests for all the loans, including rental property loans. They feel it’s safer to pay down some principal, rather than just paying interest.

In this video, we’ll explain why it's not a good idea to pay principal and interest for your rental property loan while you are still repaying loans for your family home, and the options you may have when the interest-only loan expires.

Paying interest only on investment property

Video Timeline

1. Benefits of paying interest-only on investment property loans 00:25

2. What happens when interest-only loan expires? 02:44

1. Benefits of paying interest-only on investment property loans

(1) Paying off loan for your family home faster

Suppose you still have a loan which was borrowed for your family home. In that case, the recommended way is to pay down the principal and interest on your family home loan while keeping your investment property loans on interest-only. This way keeps your repayments on investment property loans as low as possible so that you can free up extra cash to your home and pay down your home loan faster.

Although you’re not repaying anything towards the principal of your family home loan, the overall loan size (including your investment property loan as well) is reducing as you move the cash flow from your investment property loan to your family home loan.

Once your family home is fully paid off, you discharge the property from the bank. It becomes a mortgage-free property so that you max out your home protection.

(2) Potential tax benefits

If the purpose of borrowing is to buy a rental property, then the interest cost generated is tax-deductible expense, and it can be used to offset your rental property income. When you keep the investment property loan on interest-only, it helps max out the interest of the tax-deductible cost, which means it minimises the profit you need to pay. Therefore, an interest-only loan minimises the tax against the rental property.

2. What happens when interest-only loan expires?

For most banks, interest-only loans are only available for up to a five-year term. When the period finishes, the loan automatically converts to a principal and interest payment. But in some situations, you may want to extend the interest-only term, and there are some options you can choose from:

(1) Get an interest-only extension from your existing lender

Ask your current lender if you can extend your interest-only loan term to give you more time. Your lender will need to check your current income and property equity level, so that they can evaluate your ability to repay the mortgage over a longer period. Remember, there is no guarantee that you will get your interest-only loan extension approved by your current lender. Therefore, if you can’t prove that you meet their criteria, you might struggle to convince your lender to extend your term.

(2) Refinance your mortgage to another interest-only loan

Failing to get an interest-only loan extension approved from your current lender doesn’t necessarily mean that you can’t get approval from another bank. It all comes down to policy at a particular bank.

If your current lender refused to extend the term of your interest-only loan, another option is to refinance to an interest-only loan with a different lender. You can continue to make interest-only repayments for another five years and keep your costs on your investment property down.

At Prosperity Finance, we enjoy a good relationship with many New Zealand lenders, which allows us to search through many home loan options and find the right lenders to suit your situation and needs.

Get expert advice before going ahead

We recommend that having interest-only on your investment property loans while you still can. Interest-only loans can be hard to come by – your circumstances may not meet your lender’s criteria. That’s why you’ll need a mortgage broker’s help to walk you through the process.

Prosperity Finance looks at property investment loan strategically, empowering you to make the best long-term, informed decisions. Call us at 09 930 8999 to have a chat with the team at Prosperity Finance.

Learn more:

What should you do when your interest-only mortgage ends within the next two years?

Your loan interest may not offset rental income if the purpose is incorrect

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.