What You Need to Know About Interest-Only Home Loans
A home loan is made up of two parts: the principal and the interest. Principal is the lump sum of money you need to borrow. Interest is the fee you pay to the lender. Some lenders have a provision in which you pay only the interest on your loan for a set amount of time. This is called an interest-only home loan, and it’s particularly attractive to property investors.
Let’s look at why.
What's the Point of Only Paying Interest?
The simple appeal here is that monthly payments on only the interest are far lower than monthly payments on both the interest and the principal. For a limited period that usually ranges from one to five years, you only pay a relatively small portion of your loan. This saves you money in the short-term.
The Pros: Why Some Benefit From An Interest-Only Home Loan
Property investors make up the majority of those who take out interest-only loans. While their payments are solely made up of interest, they can count those as tax deductions. Throwing in payments on the principal would only reduce their tax benefits – that’s a good deal!
A skilled investor assesses property market patterns and decides the best times to buy and sell. He or she may take out an interest-only loan and use the money they save to make improvements to the property. By the time their interest-only period ends, they’re ready to sell and the property has increased in value. This ideally enables them to pay off the principal quickly and completely.
This approach also enables the investor to generate significant equity, which they could potentially use to purchase their next property.
The Cons: Why You Should Think Twice Before Paying Interest-Only
It’s that age-old cliché of what goes around comes around. You might save a few bucks for a year or more, but that principal never goes away. Sooner or later, you will have to pay that off. At some point, not only will you have to pay off whatever principal you have left, but you’ll also have some interest tacked onto that remaining value. Your monthly repayments could skyrocket by the end of your interest-only period.
Even experienced property investors shouldn’t take interest-only loans lightly. Being prepared to pay the remaining amount doesn’t mean assuming your property value will increase exponentially over the period you are making repayments on just the interest. Your property could do just the opposite. Expect and plan for the worst.
In the end, it may be better for you to just take advantage of the current low interest rates by paying both the principal and interest right now (P & I loan). Low interest rates make it tempting to enjoy low monthly interest-only repayments, at present.
But there’s always talk that interest rates could rise soon, and that could put the squeeze on you and the huge amount of Aussies who currently invest in property with interest-only loans. So beware!
Is An Interest-Only Home Loan Right For You?
To benefit from an interest-only loan, you need to be prepared with a plan to pay back the rest of the principal when the time comes, and also a strategy if interest rates rise.
Start by talking to a finance expert. Funding Options will help you crunch the numbers, and find the best loan for you (a service that comes at no cost to you!). Contact our team today to set up a free, no obligations discussion.
– Dom Cassisi, Managing Director