OPINION: Interest-only mortgages, where clients pay the only interest on their mortgage without paying any of the principal, have come under some scrutiny in the past decade.
Prior to the mid 2010s, you could often set a mortgage account to be interest only for any where up to 10 years. As interest rates began to fall and responsible lending requirements ramped up, banks typically limited the time borrowers could be on interest only payments - usually to a maximum of two years for your own home and five years for investment properties.
Despite delaying crucial principal payments, there are some good reasons why a homeowner might look to spend a year or so on interest only.
First home buyers who have used all their savings for their deposit often ask for the first year on interest only . They then mimic the principal and interest payments into flexible floating-rate account (one you can deposit and withdraw money easily from) - usually called a revolving credit account. This way, they know they can afford the payments but if their newly purchased home requires some emergency repairs which weren’t picked up in the purchase process, they have some cash available to complete them.
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But, by far, the most financially legitimate reason to make use of an interest-only mortgage was for investors. Let’s imagine someone who has 50% of their mortgage on an investment property and 50% on their personal property.
Let’s say their payments are $4,000 per month. Rather than putting $2,000 towards each loan, they might change their investment mortgage payments to interest only (making them, say, $1,000 per month) and put the remaining $3,000 per month towards their personal mortgage. They are still paying their mortgage at the same rate but they are paying down their personal mortgage which, until recently, wasn’t tax deductible.
Those of you who are up to date with the latest government changes can see how things have changed here.
Now that interest on investment properties is transitioning to non-tax deductible, there is a question as to whether there is a need to keep investment property mortgage payments on interest only. Essentially, what is the use of keeping your investment mortgage the same if the tax deductions aren’t there any more?
We are in early stages of the four-year transition to the new tax laws but here at Mortgage Lab, after discussions with several accountants, we are still suggesting investors keep their investment mortgage on interest only for a couple of reasons.
Firstly, the loss of tax deductibility is being phased in over the next four years for existing rental properties so there is still a tax benefit to maximising your mortgage until that has fully occurred.
Secondly, these sudden and unexpected changes to the tax deductibility of interest was meant to cool the property market. They were used instead of the traditional method of raising interest rates. If the market sufficiently cools, the ability to claim interest as an expense may be reviewed particularly, and I’m sure very coincidentally, as the next round of elections approaches. If the change is reversed, it would seem reasonable that investors would still want the tax-deductible portion of their mortgage (the investment property part) to be as high as possible.
Interest-only mortgages need to be treated with care.
Home owners shouldn’t rely on them for any substantial length of time as they significantly increase the cost of a mortgage over time. Investors should still look to pay down their investment mortgage once they have fully paid their personal mortgage. But for those with both investment and personal mortgages, the big change in tax deduction rules doesn’t necessarily mean a big change in mortgage structure.
All numbers are used as examples and are not meant to be taken as individual financial advice. Tax advice should be sought from a professional regarding your individual circumstance prior to any changes being made.
- Rupert Gough is the founder and CEO of Mortgage Lab
