Interest-Only Loan
When it comes to home loans, borrowers have various options to choose from based on their financial goals and circumstances. One such option is an interest-only home loan. In this article, we will delve into the concept of interest-only home loans, explore their advantages and disadvantages, and provide key considerations for borrowers contemplating this type of loan.
What is an Interest-Only Home Loan?
An interest-only home loan is a mortgage product where the borrower is only required to make interest payments for a specified period, typically between 5 and 10 years. During this period, the principal balance of the loan remains unchanged. Every repayment does not chip away at the principal loan.
After the interest-only period ends, the home loan transitions to principal and interest repayments, including the repayment of the principal amount borrowed and the ongoing interest charges. This is when your mortgage will include the principal loan rather than just the interest.
You will need to make larger repayments once your home loan transitions to a principal-and-interest loan.
Who should opt for an interest-only loan?
When it comes to mortgages, most borrowers will do well with trying to repay the loan as soon as possible – so a principal and interest (P&I) loan is the most straightforward approach.
Additionally, P&I loans typically offer lower interest charges over the life of the loan. Lastly, they let you build equity sooner (the value minus the debt that must be repaid).
However, if you want to secure a home now but prefer a lower repayment amount for the next few years, an interest-only loan frees up your cash flow for other expenses.
An interest-only loan is fitting for property investors who can maximise being more liquid to invest in other assets.
For homeowners, this type of mortgage product would be helpful to home buyers juggling several debts, including car loans and personal loans.
But it’s essential to know the repayment jump once the interest-only term ends. This could come as a shock, especially if it adds a couple hundred dollars a month to your mortgage bills. And while you can use cash for other expenses, you’re essentially paying more over the lifetime of your home loan.
What happens when my interest-only loan ends?
There are three options for when an interest-only home loan ends:
Request an extension – Lenders will want to keep mortgage clients on and may be willing to roll over your interest-only period if you are an eligible candidate.
Refinance – If you’re at the tail end of the interest-only loan, you should review your rates and finances and see if better rates are in the market.
Complete the transition – You could always ride out the entirety of the loan. This is the most convenient option because you won’t have to do new paperwork. Be sure that you can comfortably repay the P&I repayments and that your lender can give a decent interest rate.
Pros and Cons of an Interest-Only Loan
| Pros | Cons |
| Lower initial repayments: By focusing solely on interest payments, borrowers can benefit from lower monthly repayments during the interest-only period. This may free up cash flow for other purposes, such as investments, repayment of other debts, or unexpected expenses. | Higher long-term costs: While interest-only loans provide short-term financial relief, you need to consider the bigger implications. By deferring principal repayments, the overall costs over the mortgage may increase, and it may take longer to pay off the entire loan. |
| Investment strategy: Interest-only loans are popular among property investors who aim to maximize their tax deductions and improve their cash flow. By minimizing their repayment obligations, investors can redirect funds toward other investments or use them to build a property portfolio. | Higher interest rate: Interest-only loans require higher rates than standard P&I home loans. Again, this means paying more for what you are borrowing. |
| Flexibility: Interest-only home loans offer borrowers greater flexibility in managing their finances. They can choose to make additional repayments towards the principal when it suits their financial situation or take repayment holidays during the interest-only period. | Less equity: If the property does not increase in value or is hit by a market downturn during your interest-only period, your repayments would not have built any equity on the home. This is especially risky if you want to refinance or sell. |
Inquire about interest-only loans
Interest-only home loans can provide short-term financial advantages, particularly for investors or those seeking greater flexibility in their cash flow management.
However, clients should carefully consider the long-term implications, including higher costs and potential limitations on equity growth. Sometimes, the strategic approach to it could backfire and result in less equity due to home values falling.
Let our mortgage professionals help assess individual financial circumstances that will develop a sound repayment strategy to ensure the suitability and sustainability of an interest-only home loan.
