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What is an interest only home loan?

What is an interest only mortgage?

An interest only mortgage differs to a standard variable rate loan. Standard variable home loans are the most popular loan type in Australia today, and generally consist of a good degree of flexibility and allow for home owners to make additional repayments on their loan early without being slapped with a fee. Because the interest rate of a standard variable home loan fluctuates with the cash rate set by the Reserve Bank of Australia, when interest rates rise, so do all your repayments. The same applies to rate cuts, so if interest rates go down, so do your repayment amounts.

Assuming the borrower has whipped out a home loans calculator to calcuate their budget and has been consistent with their repayment amounts they should find themselves free of debt at the end of the loan period. But still, with ever increasing housing prices and today's tough economic climate, interest only home loans have become more popular.

How does an interest only loan work?

Interest only loans are a type of loan whereby the borrower only has to pay the interest on the principal balance. Because they are only required to repay the interest section, the major benefit lies in lower monthly repayments, which is why these loans are primarily intended for people purchasing investment properties. In theory, the loan will never need to be completely paid off, provided that the interest payments are made regularly.

According to financial research firm CANSTAR, interest only is common in fixed rates loans because the borrower is able to calculate future interest and therefore pay this amount in advance. Some loans can also be split with an interest-only portion to trim down the repayments necessary in the first few years of the loan. This will essentially reduce repayment amounts and keep cash flow at a higher level. Use our home loans calculator to see the difference between the principal and interest loan repayments and interest only loan repayments.  

Is interest only the best loan for me?

Interest only loans will generally work to the advantage of the regimented investor or people who are building or renovating their own home and have not stretched their borrowing power or loan to value ratio (LVR) to the breaking point.

They are a good option in the short term and can provide some ease if you are just settling into making repayments on your mortgage. These loans are best to be considered for terms between five and seven years as this is the average time a home is occupied before re-financing and selling. As with any investment, the larger the amount the more substantial the savings will be. Therefore larger mortgages will receive the most savings benefits from an interest only loan.

To compare a large range of competitive Australian home loans visit our online comparison page and work out your finances with the mortgage calculator. For all the latest home loan related tips and information read our news articles and home loan guides

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