iRefi Insider School – Interest Only Lending

TRANSCRIPTION

Interest-only mortgages for investment properties

So let’s talk about interest-only lending. Now, generally speaking, interest-only lending is for investment properties. In New Zealand, most banks are not that keen on lending for your family home on interest only. So what interest-only is, is, let’s say, you have a million dollar mortgage, your interest rate is 4.5%.

What that means is you’re going to pay interest and no principal on that million dollars. Four-and-a-half percent on a mil is $45,000 a year. You won’t have to pay any more than that. You’ll pay 45 grand a year and it’s depending on whether you’ve got a 1 year, 2 year, 3 year, you know, 5 or 10 year interest-only period. That’s the only payment you will make to the bank for the life of that loan until their interest-only term finishes and then you have to either get it extended or start paying principal and interest.

So why do people start doing this? Well, generally speaking, most people that have interest-only lending also have principal and interest lending on another property. So the common way is people are using principal and interest lending on their family home no matter how big or small that lending is and they use interest-only lending to help… For a bunch of reasons, there’s good tax benefits that we won’t jump into now.

There are short-term setup. You know, what people are trying to do is minimize their outgoing so their cash flow is as strong as it can be considering the interest rates and, you know, having the extra debt and increased borrowing power. So if you’ve got a bit of an extra surplus each month instead of a negative, some properties, especially in Auckland, are negatively geared unless they’re on interest-only lending.

So what you can get is if people are on interest-only lending, you know, that million-dollar property is 45 grand a year. Now, if people are getting $1,000 a week rental from that million dollar property, then there’s a $5,000 surplus at the end of the year.

And that might go towards rates and insurance. Maybe if it’s apartment body co-op. There’s no much buffering there. And so that’s why a lot of people need to use the interest-only lending. Otherwise, the interest investment properties are quite negatively geared and unaffordable. So interest-only lending, you know, each of the different banks have a different policy on the lengths that they will allow you to have that interest-only period and there’s different servicing calculations.

How do banks assess serviceability in relation to interest-only mortgages

Generally speaking, banks are looking to see whether you can afford the loan on principle and interest. And sometimes, they’re stress testing it on a much higher interest rate. So even if there are, you know, 3.95% interest rates for interest only, they might be testing at 6%, 7% or even 8% interest using principal and interest calculations over a 25 or 30-year period.

So even if you think you can afford that 45 grand a year with the rent coming in, just be aware that your income is very important in determining whether you’re going to be able to apply for interest-only lending. And it’s also essential to understand the tax and ownership structures and obligations that go along with interest-only lending. But why people do it on one property, especially if they still have debt on their family home, is you want to build up capital gains and equity in the property.

That’s likely to have the best growth. Let’s take your family home in Mount Wellington, you want principal and interest on that property. Capital gains is going to be higher than let’s say you own another property in Rotorua. There’ll be interest-only lending. Shift as much debt onto that property as you can. Get the tax advantages, minimize your outgoings on that property, and focus on paying down the debt just on your family home.

And that’s, you know, a short little taste of using the interest-only lending and it’s a very common thing for property investors to use it.