Home loan repayments typically cover part of the principal owing (the balance) and the interest charges. But you may be able to choose to make interest-only repayments for a limited time, which involve just paying the interest charged on your mortgage.
With an interest-only home loan, your repayments will be lower during the interest-only period, because you won’t be repaying any of the loan principal during this time. But once the interest-only period expires, your principal and interest repayments will be higher.
Interest-only home loan rates tend to be fixed, and interest-only periods often only last for between one and five years, unless you refinance. This is for your benefit, as by not paying off the principal owing, you are never reducing your debt, so you may pay more in total interest on your property over the long term.
Who are fixed rate interest-only home loans for?
If you’re investing in a property, a fixed rate interest-only mortgage could help you to keep expenses low, maximising your potential returns on investment. This may be especially true if you plan to only own the property for a short time, such as if you are thinking of “flipping” a house. Additionally, there may be tax benefits to this payment structure, as investors may be able to claim interest charges as a tax deduction.
Further, some first home buyers may opt for interest-only repayments for the first few years of their mortgage to give them some extra breathing room in their budget. Saving up for a home can be extremely expensive, and those that need time to build their savings buffer back up may opt for interest-only repayments.
However, homeowners and investors should remember that their repayments will increase significantly after the interest-only period, when they revert to making principal and interest repayments. By only making interest repayments you’ve effectively just shortened your mortgage term, while your loan remains the same size.
How do interest-only home loan repayments work?
Unsure how much your interest-only home loan repayments could cost you? Let’s break down how much your mortgage repayments could be on interest-only repayments versus principal and interest repayments.
On a 30-year, $500,000 interest-only home loan with a 5-year fixed rate of 5%, your repayments would be $2,083 in that initial interest-only period. After this time, it would increase to $2,923. Comparatively, making principal and interest repayments would cost you $2,684.
Interest-only vs principal and interest repayments:
Total cost of the loan
Option A: 5-year fixed interest-only period
5 years - $2,083
25 years - $2,923
Option B: Principal and interest repayments
30 years - $2,684
Source: ASIC Money Smart interest-only calculator. Based on a 30-year, 500,000 home loan at a rate of 5%. Option A is a 5-year interest-only period, which then reverts to 25-year principal and interest repayments. Option B is 30-years of principal and interest repayments.
So, while you may save more in the first five years with interest-only repayments, your repayments will jump by almost $900 after your interest-only period ends. Additionally, it could cost you $35,606 more in higher repayments over the life of the loan.