If only home loans came with an instruction manual explaining the difference between all the facts and figures. Understanding your repayments, interest, fees and charges can be overwhelming and it’s easy to overlook, or not understand certain aspects.
When it comes to making repayments you can simplify the process by understanding you have two options for repayment instalments. You can either make repayments on a ‘principal and interest’ basis or pay by ‘interest-only’ instalments.
Want to know the difference? Use the RateCity’s home loan interest calculator to calculate both options and by doing so, you’ll be able to estimate your repayments and determine the total amount of interest payable over the life of the loan.
So what’s the main difference, you ask?
Principal and interest loans
Making principal and interest (P&I) repayments will reduce the principal, as well as the amount of additional mortgage interest you’ll pay over the term of 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 loan is the most common variety of home loan in Australia, and RateCity’s home loan calculator lets you compare the costs of home loans in this category.
Choosing a P&I option can be a smart choice if you intend living in a property long-term. By paying off the capital, you also increase your equity stake in the home, and help speed up the path to outright ownership. Moreover, a P&I strategy simultaneously helps trim additional interest payments. Choosing a low interest home loan can also help cut the additional interest impost.
With an interest-only loan, you only pay the mortgage interest set by the lender, which means you don’t pay off any of the capital. Interest-only loans, therefore often involve selling a property to repay the principal.
Interest-only loans are typically aimed at investors. In reality, an interest-only home loan, enables investors to hang onto a rental home, which over the course of the loan, should generate rental income and possibly some capital gains. Furthermore, the interest component of the loan is tax deductible.
Typically investors, who believe they own a quality, well-located property, with solid long-term growth prospects, choose interest-only home loans.