Be Sure You Understand Interest Only Loans And Property Investment Finance Risks

Interst only loans can be of great benefit to a property investor with their property investment finance,but it is important to understand the impact it could have.

Investors are often very keen to take out interest only loans because of the lower repayments and this seems to be a good strategy at the outset. Lower repayments can be very useful when purchasing a property or refinancing to buy another. It is also a property investment strategy that lenders encourage for new investors as it will allow them to purchase a more valuable property at the outset.

But if you choose to take on an interest only loan, do be aware that there are risks involved.

So, what is an Interest Only Loan?

An interest only loan is a loan where you are only required to pay the interest on the loan in your scheduled repayments and does not pay any principal as part of the payment.

Commonly these loans are only set up for a short period of time, say 3 - 5 years, with a refinancing period at the end of that time where a lender may ask for principal to be included in the loan.

A different view is to make an interest only loan part of a split loan with an interest and principal loan being the second part of the loan set up. This giving the investor a small reduction in repayment amounts, but at the same time getting some principal repaid.

Why would you use this real estate investment strategy?

This strategy is often used when an investor wants to purchase a property, but at the same time keep their repayments as low as they can instead of taking a loan for an overly long period of time to reduce a loan repayment. With only the interest on the loan to pay each time the repayment amount is quite considerably reduced.

An investor can often purchase a property a little more expensive if the loan is interest only for the first few years. Or if an investor buys a property and the rent is not going to be sufficient to cover the outgoings of the property they may well decide to do interest only so that the short fall is not so great.

Ways to use an interest only loan to your benefit when investing in property.

There are several ways a property investor may use an interest only loan to their benefit and they could even have positive cash flow with an interest and principal loan but decide to take on an interest only loan because they have sufficient equity to purchase another property and want to keep their repayments as low as possible during the first few years of owning the extra property.

Another reason is that an investor may buy a property that needs repairs so by having lower repayments with an interest only loan the positive cash flow can be used to do the repairs or upgrade the property which will also have the effect of increasing the equity in the property. Then when the investor goes to refinance into an interest and principal loan at a later date the extra property value will help with valuations on the new loan.

Remember, property investment finance is a critical part of your success in building a property portfolio.

Understand the risks in using interest only loans.

Sound property investment strategies are important to have as part of a property investment finance plan and property investors need to understand the risks if they intend to use interest only loans as part of their strategy to build a property investment portfolio.

Interest only loans seem so attractive with the lower loan repayments but there is a risk so make sure that you understand how it could impact your investment. Here is an example:

- You purchase a property at $210,000 with no down payment because you have equity in other property

- you fund the new property with an interest only loan

- For a while all is going well, then property prices start to slip so instead of owning a property valued at $210,000 it has now slipped to $203,000

What in effect has happened is that the property is now not worth the value of the mortgage, therefore you are going to be asked to pay sufficient monies off the loan to bring it in to a neutral or positive value situation. This is where the risk comes in, because if you cannot do what the bank askes then the bank is going to sell the property because with the interest only loan you have not been paying down the principal as you have been making your repayments.

This is the risk of interest only loans and is a situation to be very aware of if you intend to use interest only loans as a finance strategy.

It is not so bad when you have good equity behind you or a good personal income, but if you are stretching yourself it could put you in a compromising situation and you might have been better to purchase a cheaper property or wait until you have more equity behind you.

Grow your property investment portfolio slowly and surely with property investment finance strategies that are sound and which are written into your investment plan.


Copyright (c) 2010 Kaye Dennan