If you are in the market for a home loan your first step should be working out how much you can afford to borrow, which can be determined by how you intend to manage your home loan interest repayments. You can either make repayments on a ‘principal and interest’ basis or pay by ‘interest-only’ instalments.
Principal and interest loans:
Making principal and interest (P&I) repayments, helps to trim the principal (or ‘capital’), as well as the mortgage interest on the home loan. That said, if you select a P&I option, your repayments will be higher than if you make interest-only payments.
A P&I option can be a smart choice if you intend to live in the property for a long time. By paying off the capital, you not only increase your own equity stake in the property, but this strategy will result in outright home ownership. Moreover as you pay down the principal, you’ll simultaneously help to reduce the interest you’ll pay over the term of the loan.
On an interest-only loan, you only pay the home loan interest set by the lender, which means you don’t pay off any of the capital. Most lenders offer interest-only loans for a limited time – up to 5 years – after which you either need to start paying back the principal, or you must reapply to continue paying the mortgage on an interest-only basis.
Despite cheaper repayments, don’t be caught unawares by interest-only repayments. For instance, when you sell a property, you will have to repay the principal in full. This may take a significant chunk out of the sales proceeds.
In truth, interest-only loans are primarily designed for investors who aim to profit from the income and capital growth generated by a well-located, quality rental property. They can also claim the home loan interest repayments as a tax deduction, whereas the principal isn’t deductible.
There is a smorgasbord of P&I and interest-only home loan options in the marketplace, and it is important to do the research before deciding on a loan that is suitable to your circumstances.