Hi Nicole,
I just read your article last week "How much you can safely borrow: the formula". My husband and I are in a similar situation as Luke of South Yarra – that is, having saved enough deposit (20 per cent) to buy our first home. My question is what is the best mortgage repayment option? Principal and interest or interest-only? We are very good savers and intend to use an offset account. Our mortgage broker advised us to take up an interest-only mortgage so that we can save up the principal outside the loan (use it to offset) rather than locking it into the asset. Would appreciate your opinion on that – thanks.
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Photo: Michael Mucci
Joyce, Blackburn
Do you trust yourself Joyce? Because going interest-only on your home loan will represent a huge temptation.
It's also unusual advice. The conventional wisdom on property debt is that your home should be principal and interest – so you chip away at this non-tax-deductible or "bad" debt and eventually the precious asset becomes yours.
While you still have a home loan, it's typically recommended to keep any "good" or deductible, investment debt interest-only. This serves the dual purpose of keeping your tax deductions high for the investment and freeing up the most money possible to throw at your home loan.
Once a home loan is gone, my preference is to switch investments to principal and interest too, because unencumbered assets equal financial freedom.
But you say you're good savers – and with a 20 per cent deposit you certainly demonstrate that. If you diligently "save what you save" due to an interest-only loan into an attached offset account (which simply nets what you hold in it off your loan balance), it would mathematically be the same as having a P&I; loan (double check money offsets at your full interest rate, though, for interest-only loans).
The advantage of your broker's strategy would come if down the track you convert this home into an investment property – having never "technically" paid down the principal, the entire amount would attract tax deductions.
There is also a really beautiful thing about an interest-only loan hooked to an offset account: money you hold in it actually reduces your monthly payments – so over time you'll have more money to pay in.
Perhaps this is what your mortgage broker is thinking. Or – I hate to be a cynic Joyce – he/she might be thinking that a mortgage broker's commission is usually based on the outstanding loan balance each year. If yours technically stays high, so might the commissions.
And you know what else? The cheapest loans on the market don't pay commissions to mortgage brokers, so they sure as hell won't recommend them. Sanity check your advice on the raft of comparison websites: mozo.com.au, finder.com.au, canstar.com.au, ratecity.com.au and infochoice.com.au among them.
Nicole Pedersen-McKinnon is a money educator and consumer advocate: themoneymentorway.com. You can write to her for help solving your money problem, or with a consumer question, at nicolehelps@fairfaxmedia.com.au.
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