When property investors should pay principal and interest on your mortgage
Since the GFC Australians have paid down a massive amount of their debt. So why have we seen record savings over the last four years?
Well, consider this.
Over the last four years we had predictions by some analyst of falls in property prices or at the very least subdued property prices. There are mixed predictions moving forward. Some are saying there won't be much growth for several years to come.
If there is no growth it's much better to pay down loans because if you are not paying interest at say 6.15% then you are earning 6.15%.
There are not many investments that are currently paying 6.15% return on your investment.
Once the property market experiences growth again you will see investors going back to interest-only loans.
At a normal long term capital growth of 8% per year plus a net rental return of 4%per year net giving a total return of 12% per year, it's better not to pay down the principal but to pay interest only.
Instead of paying the principal back you would use the principal payments to cover another interest-only loan to buy another property.
Two properties giving a return of 12% per annum less interest of 6% per annum gives you a net return on two properties instead of one property. This makes sense in a growth environment.
But this does not make sense in a declining or flat environment.
So one needs to roll with the punches.
The rule of thumb is:
1. In a growth environment pay interest only and maximise your cashflow to increase your asset base.
2. In a down market or subdued market pay down the principal. It's the best return on your cash you will get.
Ed Chan is a founding partner of Chan and Naylor accountants and a leading property tax specialist. He has co-authored three best-selling books as a seasoned property investor who understands the relationship between property investment and tax.
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