This is the fourth and final post in my introduction to personal property finance series. A very clever friend of mine commented on a previous post when discussing fixed v variable mortgages, that you can have a number of fixed mortgages. For instance, if you’d decided to fix $150k of your mortgage, you could get 3 x $50k fixed mortgages, which would allow you to repay more principal. Many financial providers restrict the amount of principal you can repay on a mortgage. So if the limit was $10k for mortgage, if you had three fixed mortgages, you could repay $30k of your total $150k fixed mortgage. Splitting your mortgages could also provide more flexibility if you wanted to fix some for one year, some for two years, and so on.

However… this is if you want to repay principal. Many people falsely assume you have to repay your mortgage and that repayments have to include principal and interest (P&I).

Now you’re probably thinking… but then I am not paying down my mortgage and I’m not “getting ahead”, or why would I want to pay the bank all of that interest?, or I thought those sort of mortgages were only for investors… Let me answer all of your concerns and show you that having an Interest Only loan is the best option for you.

First and foremost, your monthly repayments on a P&I mortgage will be higher than Interest Only. On a $100k mortgage where the interest rate if 4.69% and term is 25 years, your P&I repayment is $566.67 (P $175.84 & I $390.83). On the same mortgage, your interest only payment is $390.83. You save $175.84 a month!! When calculating how much you can repay (see previous post “What mortgage payments can I comfortably afford?”), an interest only loan may mean you could comfortably borrow more.

Secondly, if you have an offset account you don’t need to repay principal. See my previous post “What is my risk appetite regarding fixed versus variable mortgages?” for an explanation of offset accounts. If I have a $100k mortgage and $20k in savings in my offset account, this means I only pay interest on $80k. My monthly payments are even less $312.67, and my principal has been reduced by $20k. With a P&I mortgage, I am out of pocket $566.67 in the same month, and I have only repaid $175.84 of principal!! It would take almost 8 years to repay $20k via P&I repayments.

While you are not technically “repaying principal” or “paying off your mortgage” with an interest only mortgage with an offset account, you are reducing the principal amount of the loan, and therefore paying less in repayments.

So maybe you think… well that’s fine but I don’t have a spare $20k to stick in an offset account… even if you only have $1k in your offset and you deposit some small savings each month, you are a lot better off than trying to pay P&I. The more savings you deposit in your offset, the lower your mortgage payments are (incentive!) and you will pay less and less interest to the bank.

The big seller for me on an interest only mortgage with an offset account is the savings you deposit to reduce your principal is YOUR MONEY. You can do with it what you like, you can take it out when you want, and you can put more or less in each month. You can deposit $20k in your offset account and decide a few months later you want to renovate your bathroom. In the meantime you have reduced your monthly payments dramatically AND still have access to YOUR money. If you are repaying P&I, you cannot withdraw that $175.84 of principal. In time you can draw down equity on your home but that is a much more complicated process than transferring some funds from one account to another in your internet banking and hey presto! you’ve got $20k to spend on your renovations.

And finally, the question some people don’t ask themselves when buying a property is… “will I ever rent out this property” …what happens if work posts you interstate, a relative gets sick and you move to care for them, or even that you are lucky enough to buy another property to move into without having to sell the current one… your property could end up being an investment and rented out. If there is any chance this is a possibility, you should strongly consider an Interest Only mortgage as only the interest portion of your mortgage payments will be tax deductible. This leads us into a bigger discussion with regards to “gearing”, which I will cover in the next post.

So really, it’s a no brainer! Interest only mortgages are cheaper, may allow you to comfortably borrow more, with an offset account offer the ability to reduce principal significantly faster than repaying principal each month, and gives you access to that principal any time you want it, all while providing the flexibility for the future with regards to renting the property out as an investment. I promise you’ll be “getting ahead” a lot faster with an Interest Only mortgage.

Note 1: I found a few handy mortgage payment calculators: http://www.planabettermortgage.com.au/loan-calculators/p–i–interest-only.htm or http://www.infochoice.com.au/calculators/principal-and-interest-calculator/

Note 2: There has been vigorous discussion lately from various politicians that they want to get rid of Interest Only mortgages as they think they are contributing to Australia’s property “bubble”, however these mortgages are still widely available.