We know that housing prices in Australia, and particularly Sydney, are increasing. Over the last year, Australian housing prices have risen by 11% and in Sydney the rise has been 16%! As a consequence of the dramatic escalation in housing prices some of my clients have reported of late that they keep missing out on their desired properties as they get outbid. No doubt this would be frustrating and disheartening.
Recently released, the RBA’s “Financial Stability Review” reports that it is not first home buyers, but investors who are driving prices up across Australia. Investors are taking advantage of the low interest rates on offer and while generally having greater incomes than the average home owner, they are willing and able to pay more for a property. But what is their secret?
It is the use of interest only loans. You see, interest only loans give you greater borrowing power than the regular principal and interest loans.
Interest only loans are exactly as the name describes - you repay the interest on the loan only, not the principal. The idea is popular with investors as they minimise their mortgage repayments, whilst waiting for the property to grow in value.
For example, consider a $500,000 loan (5% interest rate over a 25 year term), for which your monthly repayments would be $2,923. On an interest only loan, the repayments would be just $2,083 each month, providing you with an ‘extra’ $840 each month. And a $2923 monthly payment on an interest only loan, would enable you to support a loan totalling $700,000.
In essence, by switching your mortgage to interest only, you have an additional $200,000 in buying power! This might be a good strategy to follow to win your dream house at your next auction!
Bear in mind that this strategy may not suit everybody in the long term. With an interest only loan you are not ever reducing the balance outstanding, and you miss out on the “forced saving” or wealth accumulation aspect offered by a traditional principal and interest loan.
Call me on 0438 258 888 or email me if you’d like to learn more about Interest Only Loans.