When you apply for a home loan, you generally have the option of making:
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Principal and interest (P&I) repayments, or
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Interest only repayments
If you choose to make P&I repayments, you’ll simultaneously pay interest and chip away at the amount you borrowed (the principal) as well. This means the amount of interest you pay will be calculated on a shrinking principal balance that will eventually become nothing once you pay off your loan.
On the other hand, an interest only home loan will see you paying just interest on the amount you borrowed, while the principal balance remains the same. Interest only repayments are generally only available for a set period of time.
Definition:
Principal or principal balance refers to the funds borrowed to buy a property.
Interest is what a bank or lender charges a borrower accessing those funds. Lenders will typically charge a borrower a portion – expressed as a percentage – of their loan’s principal balance each year.
Invariably, interest only repayments will be smaller than principal and interest repayments on the same home loan, as they won’t incorporate the principal component.
What are the benefits of an interest only home loan?
There are many benefits that interest only loans can offer borrowers. Let’s run through them:
1. Lower mortgage repayments
We’ve already touched on the first benefit of an interest only home loan. Interest only repayments are lower than principal and interest repayments would be on the same borrowed amount.
Let’s crunch some numbers:
If you take out a $600,000 loan with a 6% interest rate for a loan term of 30 years, you could pay $3,597 per month if you were to make principal and interest repayments.
If you were to make interest only repayments, you will be up for just $3,000 a month.
Estimate how your repayments could shrink by switching to interest only: Mortgage Repayment Calculator
It’s worth noting that making interest only repayments will only reduce your repayments for the duration of your interest only period. Your lender will still expect you to pay back your home loan by making principal and interest payments eventually.
Generally, lenders will allow owner-occupiers to make interest only repayments for up to five years, while investors might be able continue making interest only repayments for up to 10 years. When that period expires, principal and interest repayments will apply.
2. Interest only home loans can save investors while allowing tax advantages
Some investors may aim to save money while reaping certain tax benefits when making interest only repayments on investment home loans. Interest payments on mortgages funding rental properties are tax deductible, but payments that reduce the principal of the investment loan are not.
As there are no tax benefits in paying off a home loan’s principal balance, some investors might prefer to maximise cash flow instead, potentially allowing them to more easily afford expenses like maintenance or even the purchase of another investment property. Investors who’re looking to make a capital gain can employ this interest only strategy to secure a property and later sell it (ideally for a profit), before their interest only period expires a bid to maximise their returns.
You would need to do your calculations before going down this path, however. Professional advice from a tax specialist or accountant is strongly advised.
3. Interest only mortgages can help borrowers get on top of other expenses
For some borrowers, making interest only repayments for a period can give them space to find their financial feet or get on top of other debts.
As home loan interest rates tend to be lower than interest rates on other debts, deferring the principal portion of their repayments can allow them to pay down higher-interest debts and put them in a better financial position for the long term. Interest only repayments can also give borrowers breathing space should something unexpected come up, like job loss or a major unplanned expense.
In such cases, switching to interest only repayments can be an alternative to deferring home loan repayments, which many lenders will only allow under certain circumstances.
Reaching out to your lender is probably the best place to start if you want to switch to interest only repayments.
What to consider before you take out an interest only home loan
It’s important to understand that turning to an interest only home loan will ultimately cost you more in the long run. If you decide to go ahead, you’ll also need to plan for the time the mortgage reverts back to principal and interest repayments.
Ideally, the interest only period you agree to should be long enough for you to get your financial affairs in order, placing you in a good position to meet the higher repayments when the principal portion kicks in.
If you're in the market for an interest only loan, it's important you do your research to find a competitive interest rate, particularly if you're looking to get other budgetary and financial affairs in order. The table below features some of the most competitive interest only home loans on the market:
Lender Home Loan Interest Rate Comparison Rate* Monthly Repayment Repayment type Rate Type Offset Redraw Ongoing Fees Upfront Fees Max LVR Lump Sum Repayment Additional Repayments Split Loan Option Tags Features Link Compare Promoted Product Disclosure
If such an increase to your repayments is likely to present a challenge, you could consider refinancing your home loan to better meet your circumstances at the time.
Image by Towfiqu Barbhuiya on Unsplash
Collections: Interest Only Home Loan News & Guides
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