Interested in Interest Only?


Today I want to take a quick look at Interest Only home loans for you.


First, what are they?

An interest only home loan is one where your monthly payment does not include any principal payment (eg you are not paying anything off your home loan each month).

So, if you have a home loan of $400,000 and you have a 4% per annum interest rate then you are paying 4% of the $400k per year, in interest, or $16,000 per year.

That works out to be $1333 per month.

If you were paying Principal & Interest payments, like most mortgages, then your payments would be higher (as they include paying off some of your loan each month).
So, your payments would be $1909 per month, rather than $1333

Interest only payments cannot be selected indefinitely and usually are selected for a period of 3-5 years. After that your payments become Principal & Interest payments anyway.


Why would someone even want one?

Aside from the obvious reason, being the lower monthly repayment, people often choose to get an interest only home loan on their investment property loans, especially when they have a current owner occupied home loan.
This is because the interest on their owner occupied home is usually not tax deductible whereas on their investment property it can be.

So, instead of paying the extra few hundred onto the investment property debt they can redirect that onto their owner occupied home loan debt.

This is of course assuming you do the smart thing...

Another reason someone might want one is because they might be temporarily going through a lower income environment, or about to be.

Perhaps this could be whilst someone is on maternity leave, or many other reasons.


What's the disadvantages?

So, above we mention why someone might choose to have one and it sounds all rosy, but there are some major disadvantages of going Interest Only.

Firstly, the lenders are currently charging substantially more for the privilege, in the form of higher interest rates! The average interest only investment loan with a variable rate has shot up by 0.73% basis points due to rate movements, beginning last November.

One of our lenders is about to move their interest only rates up again by 0.4% which would mean that they have moved by 1.2% in only 1 MONTH!

As an example, that same lender is charging as little as 3.74% for principal & interest but as high as 4.54% for interest only (and that's before the new rate rise next month!)

This means a difference of of approx. $300 a month in extra interest you are paying to the bank...

Another disadvantage is that by going interest only it makes it harder to be able to get the loan.

When you finance a property on interest only you are essentially taking out a 30 year loan with the first 5 years as interest only, meaning you dont technically have to pay anything off the principal for 5 years. This means after the 5 years you now have payments based on 25 years which makes your minimum monthly payment higher.


So in summary, interest only home loans can be beneficial in some circumstances but in the current climate it's really worth checking with your broker to see if this kind of product really is suitable.

Remember: interest only doesn't go on forever and it's seeming quite unlikely in today’s climate that you will be able to extend the interest only period when yours eventually expires.

So, look at the payments for when you have to go back to paying principal again and if you can't afford those payments I suggest you start thinking about whether you can afford the property at all. You don't want to be the person forced to sell when all of the interest only home loans come to an end over the next few years and everyone is queuing up to do the same.

Just a thought...