Switching home loans sounds like a confronting task but paying more on your interest only loan must be more frustrating still. In an ever-changing market, it’s important to make sure you are on the ball and although interest only loans seem like the best scenario to purchase your investment property, times may have changed.
Generally, people will get an interest only loan to take advantage of the significantly lower monthly repayments. The interest on the loan is also tax deductible during the interest only period. However, with the principal and interest rates widening it’s important to consider if you would be better off with a principal and interest loan rather than an interest only loan.
Australia’s debt-to-income ratio is becoming an increasing burden and the threat of interest rate increases has interest only lending at the forefront of great concern. Therefore, you must consider if you are willing to pay a higher interest rate with an interest only loan or a lower rate which will see you paying principal and interest with higher cashflow repayments.
Let’s explore the differences in both types of loans:
Interest only loan
- Generally higher interest rate
- You are only paying interest on the amount you are borrowing
- No principal amount is paid. Principal does not reduce!!!
- Loans are interest only for between 5-10 years
- Repayments are lower during the interest only period of the loan
- Repayments are much higher after the interest only period of the loan
- The longer you have your home loan the longer it takes to repay the principal
- You may pay more interest
- You may need to refinance after the interest free period has expired
- More cashflow to put into other expenses such as maintenance and renovations during the interest only period
- Check if the fees are higher than a P&I loan
- More expensive over the life of the loan
Principal and interest loan
- Generally lower interest rate
- You are reducing your principal amount borrowed as well as paying off the interest
- Repayments are higher than an interest only loan
- You can take a loan term of up to 30 years
- Interest paid is generally less than an interest only loan
- You may choose to refinance to shorten the term of your mortgage or tap into the equity
- Check the features and fees
- An offset account can save you interest
Along with understanding your financial limits it’s important to ascertain the best course of action for your investment property loan. Choosing an interest only loan for the sole purpose of buying an investment property is a risky approach unless you’re sure you will either have the income to later pay the principal as well as being sure the property increases in value.
An interest only loan can be a well-planned part of your financial strategy. Maximising your cash-flow and the tax advantages are worth considering. However, you need to be certain when the stage comes of paying off the principal and interest you are in a situation where the financial commitment doesn’t become a burden.
The ASIC website has an interest-only mortgage calculator – https://www.moneysmart.gov.au/tools-and-resources/calculators-and-apps/interest-only-mortgage-calculator
Call one of our mortgage brokers to discuss if the short term benefits will outweigh the long term costs. There are many loans on offer and far more than only the interest rate to consider; the features of the loan and fees can impact on you paying off your home loan sooner. Let’s get together and choose the right loan for you and your circumstances.