What Are Interest-Only Loans?

Interest-only loans are just that; interest only.

The main difference between an interest-only loan and a regular principal and interest loan is that the borrower repays only the interest during the interest-only period, instead of paying back both the interest and principal loan amount.

Although the main benefit of an interest-only loan is that the borrower’s repayments will be lower, over the life of the loan, they will end up paying more. The pattern of interest-only repayments is usually for a set period of time, typically for five or ten years.

Who are interest-only home loans for?

Typically, this type of loan is popular with property investors who are looking to sell near the top of a market cycle which can be anywhere from seven to ten years. These investors aim to pay off the loan with the sale proceeds and have the ultimate goal of profiting from the potential capital growth created from when it was acquired. Of course, profits are not always to be had with losses being a potential outcome.

Interest-only loans can also be suitable for those who are building or undergoing renovations and need another place to live in the meantime. This can make it easier for both mortgage and rent payments to be made.

What are the pros and cons?

The most obvious benefit of an interest-only loan is the short-term savings with some lenders even allowing for additional payments to made during this period (should the borrower come into some extra cash).

However, it’s important to remember that interest-only loans are only a quick fix and not a long-term solution. If the Reserve Bank of Australia (RBA) increases the official cash rate or the lender increases their interest rate, the interest rate on this loan is likely to rise too.

If you are unsure if an interest-only loan is right for you, a mortgage broker can help answer any questions.

Reference: Wayne Pope, Loan Market July 2017