The Australian Prudential Regulation Authority’s crackdown of interest-only loans has been reduced as APRA tries to encourage credit borrowing. A year ago, restrictions to keep interest-only loans to 30% of all home loans were put in place. At that time around 40% of all home loans were interest-only. However, these restrictions have now been lifted.
What are Interest-Only Loans?
Compared to standard home loans, interest-only loans are more high risk because they usually have to be paid off at a lower rate within 5 to 10 years. Following the low-interest period, lenders impose rates that are higher than average. Borrowers then have to start making principal payments to pay off their debt. Due to their high rates, interest-only loans serve as financial traps for many borrowers.
Good vs. Bad Debt: What’s the Difference?
Bad debt isn’t tax-deductible. Let’s say you have a personal car, residential property and credit cards. You won’t be able to claim the interest on these as a tax deduction. An average taxpayer who, for instance, for each $100 has to pay a tax of $34. They have $66 left to pay their interest.
On the other hand, good debt is tax-deductible. If the debt is against a rental property or a business, it’s considered good debt. That means that instead of having $66 to pay off interest, the entire $100 can be used to pay of their debt.
For individuals who have both good and bad debt, reducing the bad debt as quickly as possible and leave the interest on the good debt because it is tax-deductable.
Are Interest-Only Loans Worth It in 2019?
Banks are making principal and interest loans more attractive to investors by increasing rates of interest-only loans. However, you shouldn’t only rely on what banks say are better for you. After all, they act in the interests of shareholders, not the customers. So do the math before taking out any loan.
Let’s say you’re willing to pay an extra 1% on interest-only loans to improve your tax deducting ability. If you intend to pay an extra 1%, it has to benefit you in one way or another. For example, you have to, at least, receive more deductions.
According to Dr Enticott, doing the numbers will help you identify the best option for your financial situation. However, he believes that investors with too much bad debt are always better off paying higher principal payment. Anyone with significantly low bad debt will also find principal and interest loans more advantageous.
What can I do?
You should always consult with a financial adviser or an accountant who can work the numbers for you and show you the best option.
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Our experts will be able to tell you whether an interest-only loan is for you.