What is an interest only home loan?

 

An interest-only home loan is where the repayments on the loan only cover the interest accrued on the amount borrowed. Interest-only home loans are usually for a set period, after which the loan changes to a principal-and-interest loan. During the interest-only period nothing is paid off the principal.

Typically, this type of home loan has lower repayments in the short term and might provide greater tax deductions on an investment property, but will usually be costlier in the long run.

What are the benefits of an interest-only home loan

There are a number of reasons that borrowers might choose to take out an interest-only home loan:
 

  • Lower repayments during the interest-only period – this could appeal to borrowers who have outlaid a significant amount of their savings to pay for the deposit

  • Higher tax deductions – some property investors choose an interest-only home loan to increase their tax deductions and reduce their taxable income

  • More flexibility – borrowers may prefer to have more money available to them to invest elsewhere or save, rather than begin paying off the loan immediately.

What are the considerations for interest-only home loans

No two interest-only home loans are exactly the same. It’s important to consider all the features of a loan before deciding if it’s right for you, including the following:

 

  • Principal-and-interest repayments after the interest-only term is finished – remember that when the interest-only period is over, you will need to start making repayments on the principal as well as interest accrued
     
  • Fluctuating interest rates if it’s a variable rate loan – rates on variable interest-only home loans may change during the interest-only period, affecting how much you have to repay each month

  • Growth potential of the property if investing – some investors buy property with an interest-only loan if they believe they can sell the property at a higher value before starting to pay off the principal

  • Your borrowing capacity will be lower – when you take out an interest only loan, the bank is required to determine your ability to pay back the loan over the remaining principal and interest period. For example, if you take a 10 year interest only loan your remaining term is 20 years for principal and interest amortisation (as opposed to if you took principal and interest upfront over 30 years). So you need to be able to show that you can pay back in the loan in 20 years instead of 30.

Who might interest-only home loans be suitable for

Interest-only home loans are a popular option for investors who speculate that a property will increase in value during the interest-only period, allowing them to sell and gain equity without needing to pay off any of the principal.

 

Some first homebuyers also opt for interest-only home loans to reduce repayments at the start of their loan, giving them more time to save before principal-and-interest repayments begin.

 

Deciding whether an interest-only home loan is right for you comes down to speaking with an experienced home loan specialist who can offer guidance based on your particular circumstances. Get in touch with one of our specialists for more information.

 

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