There are countless different strategies when it comes to repaying your home loan, and one that’s becoming increasingly popular is the interest-only loan. In fact the Australian Securities and Investments Commission data reported by MoneySmart suggests that one in four owner occupier loans in Australia are interest only, as well as two out of three investment loans.
If you’re looking at buying a new home and are considering your mortgage, you’re going to want to be aware of all your options. So without further ado: what exactly does interest only mean, and is it the way forward for you?
What’s the meaning of this?
With a normal principal and interest loan, you’ll make payments off the principal (or the amount borrowed) as well as interest payments. With an interest only loan, as you’d expect, you won’t pay off any of the amount borrowed, instead only making payments on the interest.
There are plenty reasons why interest only is a good idea, but you need to know whether it’s right for you before making any decisions.
What are the benefits?
One of the main benefits of paying interest-only on your loan is that your repayments will be smaller at first. For home buyers, this is a brilliant opportunity to use these savings to pay down other higher interest loans before reverting your attention back to your home loan. However, for your average home buyer this should only be a short term strategy.
On the other hand, the extra interest paid can have tax benefits for those looking to buy an investment property. For investors, interest can be claimed against their income to reduce the taxable amount.
If you’re looking to buy your first home as an investment, or branch out and buy another property, it’s worth considering the merits of paying interest only.
What are the risks?
The most important thing to remember when choosing interest only is that the principal will not reduce. If your property does not increase in value, neither will your equity, and if your home decreases in value you could be left paying a mortgage that’s worth more than your property.
Additionally, you’ll pay more interest over the life of the loan, and you’ll eventually have to pay the principal off anyway.
Importantly, your Lender will need to agree to provide an interest only period to you. For owner Occupied properties a solid reason needs to be provided. If the Lender feels that your reason relates to a shortfall in affordability, then it is unlikely to be approved.
Further if you select a three year interest only period, then you will need to demonstrate that you have affordability to repay the loan over the remaining 27 years of a maximum 30 year home loan. This can mean that you need higher levels of income to demonstrate affordability.
There are so many options when it comes to selecting the right home loan and it’s easy to tie yourself in a knot. Speak to us to see if an interest only loan is right for you.