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Interest Only or Interest-in-Advance or Principal and Interest Repayments

Interest Only is preferred by investors seeking to manage cash flow or, to maximise borrowing capacity to allow for investment portfolio expansion or, to maximise tax benefits.  Only the interest portion of a repayment is a tax deduction as it is paid with pre-tax dollars while repayment of the principal is made with after-tax dollars and is therefore non deductible.  Additionally, when the principal is reduced, less interest is charged thus reducing the tax deduction for investors but not the amount required for the monthly Principal and Interest repayment.

The original loan amount remains the same with Interest Only payments.  Investors are relying on the capital growth of the asset over time rather than building equity via Principal and Interest repayments.

The Interest Only term is commonly 5 years after which the rate reverts to Principal and Interest for the next 25 years unless another Interest Only term is negotiated.  To avoid renegotiating, many investors prefer a line of credit facility which is an interest only variable rate for the entire loan term.

Interest-in-Advance is for a 12 month period. It is a fixed rate and can be paid monthly, quarterly, or yearly in advance.  Interest Only can be either a variable or fixed rate and is paid monthly only.

Financing an Off-the-Plan Purchase

Lenders are unable to give an unconditional loan approval at deposit stage for an off-the-plan purchase because of the risks involved from the time a buyer enters into a purchase agreement until the time the property settles.  One risk for both lenders and buyers is that a new building can take up to 3 years to complete which could result in oversupply and declining values.  In this case, a property could be worth less than the original purchase price and a purchaser would need to come up with the shortfall of funds at settlement.  Also, lenders must wait until the plan has been registered with the titles office so generally full loan approval is obtained approximately 1-2 months prior to settlement.

Many investors secure off-the-plan properties by way of a long term Deposit Bond which is an alternative to a 10% cash deposit.  To be eligible for a bond, a purchaser needs to satisfy the insurer that funds are available at settlement to cover the full purchase price.  This might include obtaining finance pre-approval.