This article explores the different types of loans and interest rate structures, and outlines the advantages, disadvantages and considerations to take into account when choosing a structure for investment or non-deductible purposes.
When choosing the right type of loan to suit your needs now and into the future, there are many factors to consider.
What is the purpose of the loan?
Credit cards provide immediate access to credit that can be used for many purposes, but the interest rate is high so they are best relied on only for short-term loans.
If you need a larger loan to pay back over a longer period, consider a personal loan. These tend to be used for purchases such as holidays or cars.
As the name suggests, a home loan is used for property purchases, either for your own home or an investment. They come in a variety of forms, from the “no-frills” products with low interest rates, through to standard variable rate loans offering features such as offset accounts or redraw facilities. Home loans can alternatively be structured as lines of credit that enable a borrower to repay and redraw the loan on an ongoing basis.
Principal and interest or interest only?
A principal-and-interest loan involves a repayment comprising the monthly interest on the outstanding balance plus an amount that will reduce the principal over the term of the loan. Under an interest-only structure, the borrower pays the interest expense while the loan is held and doesn’t repay the amount borrowed until the end of the term.
If you’re borrowing to invest, the interest charged on the loan is generally tax-deductible. This means that choosing an interest-only loan, rather than a principal-and-interest structure, could be simpler for tax purposes and allow you to maximise your deductions over the term of the loan.
On the other hand, using a line-of-credit facility to buy a depreciating asset, such as a car, could mean that over time you end up owing much more than the item is worth, and pay more interest than a traditional principal-and-interest loan.
Which loan is right for me?
In determining the most suitable loan, look closely at the fees, charges and the interest rates – these can add significantly to the cost of the loan. Also, remember that you usually pay for any additional features attached to the loan. If you’re not sure, we can help you navigate your choices.