Interest & tax deductibility

Henry asks:
(updated on Friday, October 16th 2020)

I have just brought an investment property in Taranaki. My owner-occupied property in the Waikato loan is $224,000 and my rental $366,000 with the same bank. I get mixed messages about paying principal on the investment or not. Question: should I pay interest and principal on both properties or or just interest only on the rental property and put any gains onto my owner-occupied property for tax benefits? And, if so, how do I go about sorting out the tax benefits?

Our Experts Answer:

The key point here is that interest you pay on money you borrow to buy your home is not deductible for tax purposes, whereas interest you pay on money borrowed to buy a rental property is deductible. One way to look at this is to acknowledge that interest you pay on money borrowed to buy a rental ultimately costs you less. Even if the interest rates are the same, the effective cost to you of deductible interest is lower.

Accordingly, you want to focus all of your effort on repaying borrowing that has been undertaken to buy the home, where the interest is not deductible. This means you are best to put the home loan on principal and interest and prioritise repaying this debt. On the other hand, you want the loan in relation to the purchase of the rental to be on an interest-only basis and, ideally, you only want to start to repay this loan once the home loan has been repaid in its entirety.

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