Interest Only Loans

If you begin your loan with an Interest Only period, your initial repayments will be less. However, compared to loans with Principle & Interest repayments from the outset, you may be paying a higher interest rate during this Interest Only period.

Once the Interest Only period is up, your repayments will rise to cover both the principal and interest, so you need to expect a significant increase. On top of this, you’ll need to repay your principal in a shorter time frame, which may drive up your repayments.

Because Interest Only repayments will result in you paying more interest over the term of the loan, this option should only be chosen to fill a requirement that you have, such as maximising your tax advantages with a property investment. They are usually not a wise choice just to make loan repayments more affordable.

To lessen these blows, you can reduce the principal during the Interest Only period by making voluntary extra repayments or depositing money into an offset account. Keep in mind that some lenders may restrict your flexibility to do this, or charge some additional fees.

• Smaller repayments. As you are only paying the interest component on your home loan during the Interest Only period, your monthly repayments will be considerably lower than with a Principle & Interest loan.
• Better cash-flow. Lower repayments mean you could use your cash for other purposes that may be financially beneficial – pay off debts with higher interest rates, make other investments, fund a loan to purchase another property, or pay the cost of additional educational qualifications that may increase your earning potential.
• Maximise tax benefits for property investors. The interest on an investment property debt is usually tax deductible for property investors, as long as you follow the ATO rules. It should be noted, however, that owner-occupiers will not receive any tax deduction for interest if you take out an Interest Only loan. Please speak to your accountant or financial planner to discuss if an Interest Only loan is the right option for you.
• Benefits are ongoing for the life of the Interest Only term. You can often choose an Interest Only term of 1-5 or 10 years. This can be very beneficial for tax minimisation strategies and financial planning purposes, so please speak to your accountant or financial adviser to find out how to make it work for you.
• Construction Loans and Bridging Loans. Assist in keeping your outgoings low during construction or bridging periods.

• You may not build home equity. Interest Only loan repayments do not help you to pay off the principal and build equity in your property. If property prices do not rise during the Interest Only period of the loan, you will not have improved your financial situation.
• No protection against falling house prices. If your property becomes less valuable before you repay any of the principal, you may end up owing more than it is worth. You could even be forced to sell at a loss.
• Increased repayments after the Interest Only term. The loan converts to Principle & Interest as soon as the Interest Only period ends, so you should plan for the end of your Interest Only period. At that time, some lenders may allow you to renegotiate another Interest Only term. Otherwise, you will need to plan for increased repayments, consider refinancing the loan, or selling the property.
• You may miss out on paying down your loan faster. As you are not reducing the balance of your loan during the Interest Only term, you will likely be paying off your mortgage for longer. Paying as much as
  you can off the principal while rates are low could mean that when interest rates rise, you will be paying those higher rates on a reduced loan balance. This could mean lower loan repayments and/or paying less interest in the long-term.
• A loan with an Interest Only period will cost more in interest over the life of the loan, than a loan that has Principle & Interest repayments from the outset. The cost differentials can be quite significant and should be clearly understood.

For example:
With a normal P&I Loan for $500,000 at 4.78% p.a. based on an LVR of 80% over 25 years, the total cost of interest on the loan would be $357,766 over the 25-year period.

For the same loan with an Interest Only period of 10 years, the total cost of interest on the loan would be $440,443 over the 25-year period and therefore would cost you an additional $82,676 in interest compared to a loan that had P&I repayments over the full 25-year term.