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What is an interest only home loan?

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.

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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Learn more about home loans

What is an interest-only loan? How do I work out interest-only loan repayments?

An ‘interest-only’ loan is a loan where the borrower is only required to pay back the interest on the loan. Typically, banks will only let lenders do this for a fixed period of time – often five years – however some lenders will be happy to extend this.

Interest-only loans are popular with investors who aren’t keen on putting a lot of capital into their investment property. It is also a handy feature for people who need to reduce their mortgage repayments for a short period of time while they are travelling overseas, or taking time off to look after a new family member, for example.

While moving on to interest-only will make your monthly repayments cheaper, ultimately, you will end up paying your bank thousands of dollars extra in interest to make up for the time where you weren’t paying off the principal.

What is 'principal and interest'?

‘Principal and interest’ loans are the most common type of home loans on the market. The principal part of the loan is the initial sum lent to the customer and the interest is the money paid on top of this, at the agreed interest rate, until the end of the loan.

By reducing the principal amount, the total of interest charged will also become smaller until eventually the debt is paid off in full.

How can I calculate interest on my home loan?

You can calculate the total interest you will pay over the life of your loan by using a mortgage calculator. The calculator will estimate your repayments based on the amount you want to borrow, the interest rate, the length of your loan, whether you are an owner-occupier or an investor and whether you plan to pay ‘principal and interest’ or ‘interest-only’.

If you are buying a new home, the calculator will also help you work out how much you’ll need to pay in stamp duty and other related costs.

When does Commonwealth Bank charge an early exit fee?

When you take out a fixed interest home loan with the Commonwealth Bank, you’re able to lock the interest for a particular period. If the rates change during this period, your repayments remain unchanged. If you break the loan during the fixed interest period, you’ll have to pay the Commonwealth Bank home loan early exit fee and an administrative fee.

The Early Repayment Adjustment (ERA) and Administrative fees are applicable in the following instances:

  • If you switch your loan from fixed interest to variable rate
  • When you apply for a top-up home loan
  • If you repay over and above the annual threshold limit, which is $10,000 per year during the fixed interest period
  • When you prepay the entire outstanding loan balance before the end of the fixed interest duration.

The fee calculation depends on the interest rates, the amount you’ve repaid and the loan size. You can contact the lender to understand more about what you may have to pay.