An interest-only home loan can be a great choice for financing a property. For one thing, the prospect of lower repayments for at least a certain timeframe is a big positive.
But it’s worth bearing in mind that along with the potential plusses, they can have drawbacks. And as with any financial commitment, it’s important to do your research!
What is an interest-only home loan?
An interest-only (IO) home loan is an arrangement where, for a set period of time, you only repay the interest on the amount you have borrowed. That means you don’t have to repay the principal (the loan amount) during that period – as you would with a principal and interest (P&I) loan.
During the interest-only period your repayments will be lower – but they’ll go up once you start paying off the principal component of the loan. The maximum interest-only loan period is typically five years for owner-occupiers, but may be longer for investment loans. After this period, the loan reverts to principal and interest repayments.
Typically, the interest-only period comes in one chunk at the start of the loan term. However, some lenders may offer borrowers the ability to switch between interest-only and principal and interest repayments.
Pros and cons of an interest-only loan
Pros:
- Lower repayments during the interest-only period can free up money to pay other debts.
- Potentially useful for short-term loans, such as bridging finance or a construction loan
- If you’re an investor, you could claim higher tax deductions from an investment property.
Cons:
- The interest rate can be higher than on a principal and interest loan – meaning you end up paying more over the life of the loan.
- During the interest-only period, the amount borrowed doesn’t reduce.
- Your repayments will increase after the interest-only period, which may not be affordable.
- If your property doesn’t increase in value during the interest-only period, you won’t build up any equity. This can put you at risk if there’s a market downturn, or your circumstances change and you want to sell.
Why interest-only loans can be perfect for a property investor
Okay – as we’ve said – generally speaking, interest-only home loans can work out to be more expensive than principal and interest loans in the long run.
However, if you are a property investor, an interest-only loan could be a perfect choice for a number of good reasons:
- Higher tax deductions from the property will mean more negative gearing for some investors.
- The lower repayment during the interest-only period can help you to accumulate a deposit more quickly for another investment property – or contingency funds to cover any potential repair works.
- By not having to pay principal initially, it also allows you to put extra money towards non-tax deductible debts.
Contact Us
If you’re not sure whether an interest-only loan is the best choice in your circumstances, OzBrokers are here to help. Please don’t hesitate to let us know if you’d like a free consultation!