If you’re in the market for a new home loan or refinancing an existing home loan, it is important to understand how you intend to manage your interest repayments. You can either make repayments on a ‘principal and interest’ basis or pay by ‘interest-only’ instalments. To work out which option is best for you, try using our home loans calculator.
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 – the results might just surprise you!
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 mortgage 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 in some cases – after which you either need to start paying back the principal, or you must reapply to continue paying the home loan on an interest-only basis.
How they stack up
Let’s take a $400,000 home loan as an example at a rate of 7 percent interest and loan term of 25 years. Paying the principal and interest option might set you back around $2800 per month, while the interest only option might seem more affordable at around $2300 per month. Now, consider the total amount of interest paid on each option – around $448,000 overall when paying principal and interest compared to a whopping $700,000 in total for the interest-only option!