Interest-only loans (IO) and principal and interest loans (P&I) have distinct features, and choosing between them involves considering your financial goals, borrowing power, and priorities as an investor. 

Key Ideas: 

• Flexibility and Cash Flow: IO loans offer better cash flow during the interest-only period, providing flexibility. P&I loans, on the other hand, contribute to reducing the overall loan balance. 
• Borrowing Power: Borrowing power is affected by the repayment structure. Some lenders use a buffering approach, reducing borrowing power for IO loans. However, others may assess actual repayments, influencing borrowing capacity. 
• Interest Rate Factor: IO loans typically have higher interest rates, and investment loans often have higher rates than owner-occupied loans. This combination results in a higher rate for IO investment loans. 

• Tax Deductions: Interest payments on IO loans are fully tax-deductible, whereas only the interest portion of P&I loans qualifies for tax deductions. 

Case Study: Difference in Interest Paid: Consider a $500,000 loan for an investment property: 

• P&I at 4.09% p.a. 
• IO for 5 years at 4.34% p.a. 

The total interest payable for P&I is $368,713, while for IO, it’s $407,728. The additional interest paid during the IO period is $39,015. However, IO provides extra cash flow of $36,235 in five years. 

Borrowing Power Factor: For some lenders, IO loans reduce borrowing power by buffering repayments. Others may use actual repayments, potentially allowing higher borrowing power. The difference in methodology can significantly impact borrowing capacity. 

Optimizing Tax Deductions: Interest payments during the IO period are fully tax-deductible. In contrast, only the interest portion of P&I payments qualifies for tax deductions. Investors should consider tax implications in their decision. 

Tips for Property Investors: 

• Multi-Lender Strategy: Use lenders with conservative borrowing power for P&I loans initially. When borrowing power is exhausted, switch to IO loans with lenders allowing higher borrowing, even with slightly higher rates. 
• Debt Repayment Strategy: Prioritize paying off expensive debts first, considering the tax-deductibility of loans. Home loans, though having lower interest rates, are usually not tax-deductible. 

• Exit Strategy: Plan for the end of the IO term. Develop a budgeting plan for the transition, as lenders may require new assessments for IO extensions. 
• Consider Fixed-Rate Loans: Fixed-rate loans may be cheaper than variable rates, offering stability in repayments. 

Understanding your goals and assessing the impact on cash flow, interest payments, borrowing power, and tax deductions will guide your decision between IO and P&I loans as a property investor.