What do I need to know about interest-only loans?

June 14, 2016

 

In your quest to find the right home loan, you might have encountered the term "interest-only loan", and wondered what it meant. To help you make an informed decision, here's a quick rundown on what they are, what benefits they have and what risks there could be.

Interest and principal

Interest-only loans are different from standard loans in that you only pay off what you are accruing in interest to begin with, usually for the first five of your loan. You don't pay off the principal, and as a result you will not need to make as large a mortgage repayment as you would with a standard loan.

After the interest-only period is up, you will revert back to a normal mortgage, where you are paying off the principal as well as the interest.

For owner-occupiers

The Australian Securities and Investments Commission found that interest-only loans tend to be more popular for investors (more on that later), but some owner-occupiers still choose to take them on over a standard loan. It can be a good deal, giving you the opportunity to make lower repayments in your mortgage's infancy, and you can also use an offset account to help reduce your repayments even further.

However, you have to be aware that your repayments will be going up at the end of the interest-only period, and you must factor this into your home loan comparisons when considering if you will be able to sustain it further down the line. You will also not be building as much equity in your home by not paying off the principal. Be aware of these pros and cons before going down the interest-only path.

For investors

Many investors choose to take on interest-only loans for the exact reason that they are cheaper to maintain initially, allowing them to rapidly expand their portfolio. The equity issue is also not as much of a big deal, as investors are offsetting this through targeting properties that experience rapid capital gains.

As a result, the house will be building equity at the top end, rather than through repayments at the bottom end. The fact that you can also claim your repayments come tax time is an added benefit for investors as well.

Remember, if you are considering taking on an interest-only loan, make sure you speak to us to ensure that it is the right choice for you!

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