It used to be that whenever there was a shortfall in the Government budget, the tax on cigarettes would go up. Almost every budget would contain an increase to that tax. While the increases are often couched in terms of good intentions to encourage smokers to quit, we all know that it’s a grab for cash. Smokers as a group have little incentive to give up cigarettes based on price alone. Given that smoking can kill, any increase in price has almost no relevance to someone who is prepared to die rather than stop their habit.
So when I see Banks slowly increasing their interest rates, out of cycle like they are right now, it makes me think that investors are being singled out as a group, like smokers, in a blatant grab for cash. The increases are being spoken about in terms that suggest the Banks are doing us all a favour by keeping the costs of a Principle and Interest loan down, as if this somehow justifies the rise. Not surprisingly, they will go to any length to make that point and while that might make sense to non-investors, it makes absolutely no sense to me.
I was particularly impressed with the efforts of one Lender who said that it was increasing the rate for those who choose to pay interest only and they encourage anyone who wants to take advantage of the lower rate to switch to principle and interest repayments. Sounds logical doesn’t it? Unfortunately there is one small problem with this statement.
It may be a lower rate switching to Principle and Interest but you will actually pay more.
That’s because Principle and Interest repayments are always bigger than Interest Only. Always.
So what the Bank is actually saying is that you have to pay more back to get a lower rate.
Let’s use a typical loan as an example
$400,000 loan 30 year term at 5.00% variable rate
Principle and Interest $2147 p/m
As an average lenders add a premium of 0.10% for investment loans taking our example to 5.10%.
That’s an $83 p/m increase
Rather than pay an increase of $83 p/m they want you to pay an EXTRA $447 p/m from what you were paying before the increase. To get a lower interest rate you actually pay more than you did before. To make matters worse, the principle portion of the repayment cannot be given back to you without a formal loan application.
How is that better?
This is not about affordability either. Whether you can afford the loan has already been established. The selection of Principle and Interest or Interest Only has little impact on borrowing capacity because Lenders treat it all as Principle and Interest anyway. They know you can afford the repayments because they bump up the qualifying criteria so much. That’s not a bad thing by the way, but once you have the loan you are treated differently. Suddenly an investor can afford to pay more than an owner occupier, even though an investor has a home Loan too.
What is obvious is that an investor appreciates money differently than a non-investor.
Because, what you do with that $447 every month is the secret to creating wealth. If you give it up you lose control, if you spend it you waste it and it’s gone. What serious investors do is allocate that money to work in the most efficient manner while still maintaining control around it’s availability.
Having money and controlling your own money is the key to creating wealth. Do wealthy people hand over control of their money to someone else? Absolutely not. So why would you? Principle and Interest is handing over control of your money to the Bank for the promise of a lower interest rate. While you may feel good about seeing the debt decrease, every dollar is now out of your control.
Interest only gives you control and the Banks don’t like it.
They say Interest Only is risky for them so you get penalised with an increased interest rate, but it can’t be that risky because they gave you the money in the first place.
On the other hand, if you are using Interest Only to balance your cash flow then you definitely can’t afford the Principle and Interest repayment that is sure to follow.
Let’s be clear. If you can’t budget then don’t bother with Interest Only. It’s that important. If you don’t know how to do a budget come and see us now because we can help you, but don’t do Interest only without a budget otherwise you might just find out that all you have done in 5 years is spend more. Those sorts of habits give weight to the argument that there is no benefit.
Interest Only is NOT a cheaper way to borrow; it is a SMARTER way to invest.
Next time there is an increase in the tax on cigarettes I will know exactly how it feels because I’m an investor.