One of the biggest misconceptions first-time property investors tend to have is that you need to pay off your investment mortgage to get ahead and build wealth.

Conversely, when you run the numbers, long term capital growth creates more wealth than paying down debt.

Take the example of a $500,000 property, financed at 100% on a 30- year principal and interest table loan. It will take the full 30 years to pay off the $500,000 principal, and based on my standard cash flow model; it would cost you $84,409.97 worth of mortgage top ups to hold that property.

However, that same property would create the same $500,000 worth of equity through capital growth within the first 15 years of ownership, based on a 5% capital growth rate.

While you can no-doubt pay off your mortgage and achieve capital growth at the same time, this indicates that real wealth is created by holding assets that increase in value over time.

This is the reason why many property investors use interest-only loans: because they require smaller payments; and investors can typically buy more property using this type of loan than the alternative principal-and-interest.

Here’s an example to illustrate my point:

The weekly payments on a $500,000 mortgage at 3.75% over 30 years are $534 a week. That’s $173.42 more than an interest-only loan, which would be just over $360 a week.

That additional servicing power can be used to buy more property and get more capital gain.

Say you bought the above $500,000 property with 100% lending and rent it for $500 a week, by my forecasts, this property would be negatively geared by $229 a week in the first year on the principal and interest mortgage.

If the same property used an interestonly loan, it would be negatively geared by $56 per week in the first year.

For the same level of input per week, you could buy three more properties using interest-only and achieve capital growth on all four of them.

The Two Scenarios

Say you were conservative and bought properties in total and put them on interest-only loans. The two scenarios we now have are:

Scenario #1 You have one property that you are paying principal and interest on, and contributing $229 per week to.

Scenario #2 You have three houses that you are paying interest-only on, and topping up by $168 a week in total.

Results

The difference between the two scenarios is significant. At the end of the 30-year period:

In scenario #1 you would have one freehold property worth just over $2 million (using 5% compounding growth every year).

In scenario #2 you would have three properties, collectively worth just over $6.17 million, with $1.5 million worth of lending secured against them. This means you have $4.67 million of equity.

It’s the same period, with the same priced houses, but scenario #2 generates 227% of the wealth of scenario #1.

One reason some investors shy away from interest-only loans is the fear of increased repayments if the interest-only period stops at the end of five to 10 years. This would mean the investor would need to pay off the principal in 20 to 25 years and face higher payments.

When you run the numbers, these fears are mathematically irrational. That’s because your mortgage (the biggest expense of any property) is not impacted by inflation, whereas the rent you charge your tenant is.

This means that by the time your mortgage becomes principal and interest, your rent has increased to the point where it can cover a larger proportion of these higher repayments. Investors can then have more consistent cash flow and put less money into the property than if they used principal and interest from day one.