To opt for interest only home loan and save for next property down payment or keep paying P&I to reduce debt AND borrow more for next property

Question

I currently own an investment property which I bought to live in (lived in for couple of years) and now has rented out as I moved (renting) in a better area for kids school.

I am comfortably managing to pay P&I on my current investment loan and trying to save as much for 20% deposit to buy home for living in( say in next 3 years). My question is: Should I switch to interest only loan for the duration i am saving deposit to buy my home? or should I continue P&I investment loan so that I will have equity, less debt (which will allow to comfortably borrow for the next home), breaking down the numbers gets to below scenario:

P&I: will be paying $300 out of MY pocket (rest will be from rental income) each month + 5K yearly for management/council etc. expenses. So total spending around 9K each year.

Interest only: saving $400 each month(difference between IO monthly repayment and the rental income I receive) + 5K yearly for management/council etc. expenses.

Will be receiving tax deduction on loan interest and all other expenses.

Any advise will be appreciated, this is to weight all options before I speak to financial adviser so that i know what advise I am getting/pros and cons.

I am typically a conservative old school who always want to have less debt, also geography is Australia (for the context).Currently i own 25% of the home.

Answer 1

Considering that you can claim a tax deduction for the mortgage interest on the investment property but not on the mortgage interest on a future house you plan to live in, you are better off paying Interest Only on the investment property so that you can save as much as posible for your main residence.

The more you can save means the less you need to borrow for the new house. Once you have you new main residence you shoul make that P&I and pay it off as soon as possible. Once you have fully paid off your main residence then you could start paying P&I on your investment property if it gets you a lower interest rate.

Answer 2

The main disadvantage of an interest only (IO) loan is that it typically has a higher interest rate than principal plus interest (PI) loans. If the rates were identical, then for a disciplined person it would be better to choose the IO loan, because then you can decide if and when it makes the most sense to start paying down the loan. For example, you might choose to do something more lucrative with the money like invest it at a higher return, or pay down a higher interest loan first. Similarly, when given the option of a 15 year or 30 year loan at identical rates, you should choose the 30 year loan for the same reason. If it makes sense you can make larger payments to make a 30 year loan act like a 15 year loan (or lower!), but in months where you'd rather have the extra money for something else you don't have to make the larger payment. So it really boils down to if you believe you can get a better return on your money.

Note, I emphasized a disciplined person because absent of that quality an IO loan may never get paid off, and could end up causing regret down the road. Having a PI loan forces some level of discipline upon you, at the cost of less control over your money.