Compare interest only home loans
Compare interest only home loans and calculate repayments to find mortgage options that may suit your needs. Check the pros and cons to work out if an interest only mortgage is a good idea for a home or investment property.
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What are interest-only loans?
Most mortgages are principal-and-interest loans, which require borrowers to simultaneously pay interest and pay down their principal.
However, with interest-only loans, borrowers only pay interest, which means their principal doesn’t get reduced.
For example, imagine you wanted to buy a $440,000 property. You might borrow $350,000 at an interest rate of 5 per cent, with the mortgage spread over 30 years and repayments scheduled for each month.
If you had a principal-and-interest loan, you would have to pay $1,889 per month – $1,468 of that would be interest, while the other $421 would go towards reducing the principal. (So, after one month, your mortgage would be reduced from $350,000 to $349,579. After two months, it would be reduced to $349,158.)
If you had an interest-only loan, you would have to pay just $1,468 per month. This would be nothing but interest, so your outstanding mortgage would remain at $350,000.
Generally, interest-only loans last for a maximum of five years, at which point the loan automatically reverts to a principal-and-interest loan (although some lenders will allow you to extend the interest-only period).
In the example above, you would now be left with 25 years to repay your $350,000 mortgage, which would require monthly repayments of $2,056.
If you did five years of interest-only followed by 25 years of principal-and-interest, your total cost would be $704,920. If you did 30 years of principal-and-interest, your total cost would be $679,995 – a difference of $24,924.
How do interest-only loans work?
Let’s take the example quoted above – a 30-year mortgage worth $350,000 with monthly repayments and an interest rate of 5 per cent.
The table below shows what would happen if the mortgage functioned as a principal-and-interest loan for the entire 30 years.
It also shows what would happen if you went interest-only for five, 10 or 15 of the 30 years, before switching to principal-and-interest for the remainder of the loan term.
|Scenario||P&I loan||IO for 5 years||IO for 10 years||IO for 15 years|
|Monthly repayments during interest-only period||$1,889||$1,468||$1,468||$1,468|
|Monthly repayments after interest-only period||$1,889||$2,056||$2,320||$2,778|
|Total repayments made||$679,995||$704,920||$732,963||$764,300|
|Additional interest paid due to the interest-only period||$0||$24,924||$52,968||$84,305|
What are the pros of interest-only loans?
Clearly, people take out interest-only loans so they can reduce their repayments during the interest-only period.
But the real point of interest-only loans is not so much to save money but to use this money to do something else.
In the example above, you’d be left with an extra $421 in your pocket each month.
The boxes below show three ways you could use that extra money to your advantage.
Pro #1. Enter the market ahead of schedule
If you were a young first home buyer, you might not be able to afford to buy your hypothetical $440,000 property if you had to pay $1,889 per month. However, you might be able to afford it if you only had to repay $1,468 per month for the first five years.
Sure, you’d have to pay an extra $24,924 over the life of the mortgage. But if you held off entering the market until you had enough money to afford a principal-and-interest loan, your property might end up costing you an extra $30,000 or $40,000.
Also, by the time your mortgage reverts to principal and interest, your salary is likely to be higher, which would hopefully mean that you could now afford the increased repayments.
WARNING: This strategy could backfire if your property doesn’t increase in value during the five-year period or if you can’t afford the higher repayments once it ends.
Pro #2. Buy an investment property ahead of schedule
Imagine that you used an interest-only loan to enter the market ahead of schedule – but this time with an investment property. And imagine the value of this investment increased by 10 per cent during the interest-only period.
In that case, your property’s value would climb from $440,000 to $484,000 – so you’d pay an extra $24,924 in repayments to gain an extra $44,000 in equity.
Also, if your investment property was negatively geared, you’d be able to use some of the interest payments to reduce your taxable income.
WARNING: This strategy could backfire if your property doesn’t increase in value during the five-year period or if you can’t afford the higher repayments once it ends.
Pro #3. Repay higher-interest debt
Starting your mortgage with an interest-only term could be smart if you also had to repay other debts that were priced higher than the 5 per cent being charged for your mortgage.
For example, you could use the extra $421 per month to pay off a car loan (at, say, 8 per cent), a personal loan (12 per cent) or a credit card debt (15 per cent).
WARNING: This strategy could backfire if you didn’t use the extra money to repay the other debts or if you couldn’t afford the higher repayments once your interest-only period ended.
What are the cons of interest-only loans?
There are two big disadvantages with interest-only loans.
First, your mortgage doesn’t decrease during the interest-only period.
Second, you end up paying more over the life of the mortgage.
The other disadvantage is that the repayments you will be charged once you move from interest-only to principal-and-interest will be higher than if you’d been on principal-and-interest all along.
That could cause problems if your financial position hadn’t improved during the interest-only period.
How do you compare interest-only loans?
You should compare interest-only loans by looking at these five main factors:
- Advertised rate
- Revert rate
- Comparison rate
All five factors are explained in more detail in the boxes below.
Factor #1. Advertised rate
The advertised interest rate is an obvious place to start when comparing interest-only mortgages.
All things being equal, a home loan with a lower interest rate is better than a home loan with a higher interest. However, as the other comparison points below illustrate, all things are often not equal.
Factor #2. Revert rate
Once your interest-only period ends, your interest-only home loan will revert to a principal-and-interest (P&I) home loan. Lenders generally charge a different interest rate for P&I mortgages than interest-only mortgages, so you’ll also want to compare these ‘revert rates’ when doing your research.
Factor #3. Fees
Interest-only home loans can come with a range of fees that can add significantly to the cost of the mortgage.
You may be asked to pay upfront fees when you apply, monthly/annual fees during the life of the loan and discharge fees whenever you close the loan.
Factor #4. Comparison rate
When you research interest-only mortgages, you’ll be shown two interest rates - the advertised rate and the comparison rate. The advertised rate is just what it looks like - the interest rate you’ll be charged. The comparison rate, by contrast, combines the advertised rate with the main fees you’ll have to pay.
As a result, the comparison rate tends to give a better view of the total cost of the loan than the advertised rate.
Factor #5. Features
Interest-only mortgages may include a range of features that make the loan more flexible and easier to repay. Features might include:
- Offset account - an offset account is a linked transaction account that not only gives you ready access to cash but also reduces how much interest you’re charged. For example, if you have an outstanding mortgage of $500,000 and an offset account balance of $20,000, you’ll be charged interest on $480,000 rather than $500,000.
- Redraw facility - a redraw facility allows you to ‘borrow back’ (or redraw) any extra repayments you’ve made. A redraw facility also reduces how much interest you’re charged, just like an offset account.
- Loan split - a loan split allows you to divide your mortgage into two loans if you can’t decide whether to choose a variable rate or a fixed rate. One loan would have a variable rate and the other would have a fixed rate.
- Repayment holiday - some lenders will allow you to pause your interest-only mortgage repayments to help you through a life event, such as a pregnancy. However, please note that when your repayment holiday ends, your monthly repayments will probably be increased so your home loan is still paid off according to the original schedule.
Who has the best interest-only loans?
Unfortunately, it’s impossible to say who has the ‘best’ interest-only loans.
One reason is that mortgages are highly subjective - one person might prefer a loan that has a lower interest rate but no offset account, while another might prefer a loan that does have an offset account but comes with a higher rate.
Another point worth mentioning is that lenders often change their interest rates, fees and policies, so whichever interest-only loan you consider the best today might not be the best tomorrow.
Why would I want an interest-only home loan?
Interest-only loans aren’t for everyone, because they come with both risks and disadvantages.
For some people, though, interest-only home loans can make sense, because the mortgage payments are smaller (at least before it reverts to a principal-and-interest loan).
These ‘savings’ can then be used for other purposes, such as buying another property.
Are interest-only home loans for investors or owner-occupiers?
While interest-only home loans are typically more popular for investors, they can be requested by owner-occupiers. But, while any homeowner can request interest-only as a mortgage repayment option, it does not necessarily mean this is the best financial decision for every borrower.
As mentioned above, there are risks involved with not repaying the principal on a mortgage. For owner-occupiers, it is expected that you’ll be repaying the mortgage for a number of years, if not decades. Investors may opt for interest-only repayments to keep expenses down and increase their net profit, particularly if they intend to flip a property within two to five years. However, owner-occupiers are – generally speaking – more likely to live in the property for a number of years, much longer than the typical interest-only window.
This means that by the time the interest-only period is over, an owner-occupier probably may not have chipped away at their principal. They may find their ongoing mortgage repayments are now significantly higher as the loan term has decreased, but not the total loan amount owing.
How do you take out an interest-only loan?
There are three ways you can take out an interest-only loan:
- Use a comparison site (like RateCity)
- Go through a mortgage broker
- Go direct-to-lender
Are interest-only loans dangerous?
Interest-only loans can be useful products when they’re managed properly - but they can be dangerous when they’re not.
The danger lies in not being able to afford the mortgage repayments once the loan reverts from an interest-only mortgage to a principal-and-interest (P&I) mortgage.
During the interest-only stage, your repayments will be lower than if you had taken out a P&I loan. But once the loan reverts to P&I, your repayments will be higher.
Imagine you take out a $400,000 mortgage with a 30-year loan term and an interest rate of 4.5 per cent. The table below shows how your repayments would differ if you chose a standard P&I loan or a loan with a five-year interest-only term.
|Scenario||P&I loan||IO for 5yrs|
|Monthly repayments in years 1 to 5||$2,027||$1,500|
|Monthly repayments in years 6 to 30||$2,027||$2,223|
|Total repayments made||$729,627||$756,999|
|Additional interest paid due to the interest-only period||$0||$27,372|
Should I take out an interest-only loan?
People sign up for interest-only loans because they allow you to lower your repayments during the interest-only period.
However, these initial savings come at a cost – literally.
First, you’ll have to accept higher repayments once the interest-only period ends.
Secondly, you’ll have to pay more over the life of the mortgage.
That’s why you should think carefully before taking out this sort of loan.
It sounds obvious, but you should only choose an interest-only loan over a principal-and-interest loan if you’re convinced the short-term gains will exceed the long-term costs.
The key, though, is to actually do your sums.
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Property Personal Finance Writer
A property and personal finance writer, Nick Bendel covered property, loans, credit cards, superannuation, and other bank products. Nick has previously written for The Adviser, Mortgage Business, Lifehacker, Business Insider, Yahoo Finance, and InvestorDaily, and loves getting elbow-deep in the latest ABS, APRA and RBA data.
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Frequently asked questions
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.
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.
How do I calculate monthly mortgage repayments?
Work out your mortgage repayments using a home loan calculator that takes into account your deposit size, property value and interest rate. This is divided by the loan term you choose (for example, there are 360 months in a 30-year mortgage) to determine the monthly repayments over this time frame.
Over the course of your loan, your monthly repayment amount will be affected by changes to your interest rate, plus any circumstances where you opt to pay interest-only for a period of time, instead of principal and interest.
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.
What is the best interest rate for a mortgage?
The fastest way to find out what the lowest interest rates on the market are is to use a comparison website.
While a low interest rate is highly preferable, it is not the only factor that will determine whether a particular loan is right for you.
Loans with low interest rates can often include hidden catches, such as high fees or a period of low rates which jumps up after the introductory period has ended.
To work out the best value for money, have a look at a loan’s comparison rate and read the fine print to get across all the fees and charges that you could be theoretically charged over the life of the loan.
How long should I have my mortgage for?
The standard length of a mortgage is between 25-30 years however they can be as long as 40 years and as few as one. There is a benefit to having a shorter mortgage as the faster you pay off the amount you owe, the less you’ll pay your bank in interest.
Of course, shorter mortgages will require higher monthly payments so plug the numbers into a mortgage calculator to find out how many years you can potentially shave off your budget.
For example monthly repayments on a $500,000 over 25 years with an interest rate of 5% are $2923. On the same loan with the same interest rate over 30 years repayments would be $2684 a month. At first blush, the 30 year mortgage sounds great with significantly lower monthly repayments but remember, stretching your loan out by an extra five years will see you hand over $89,396 in interest repayments to your bank.
How much are repayments on a $250K mortgage?
The exact repayment amount for a $250,000 mortgage will be determined by several factors including your deposit size, interest rate and the type of loan. It is best to use a mortgage calculator to determine your actual repayment size.
For example, the monthly repayments on a $250,000 loan with a 5 per cent interest rate over 30 years will be $1342. For a loan of $300,000 on the same rate and loan term, the monthly repayments will be $1610 and for a $500,000 loan, the monthly repayments will be $2684.
What are the different types of home loan interest rates?
A home loan interest rate is used to calculate how much you’ll pay the lender, usually annually, above the amount you borrow. It’s what the lenders charge you for them lending you money and will impact the total amount you’ll pay over the life of your home loan.
Having understood what are home loan rates in general, here are the two types you usually have with a home loan:
These interest rates remain constant for a specific period and are a good option if you’re a first-time buyer or if you’re looking for a fixed monthly repayment. One possible downside of a fixed rate is that it may be higher than a variable rate. Also, you don’t benefit from any lowering of interest rates in the market. On the flip side, if rates go up, your rate won’t change, possibly saving you money.
With variable interest rates, the lender can change them at any time. This change can be based on economic conditions or other reasons. Changes in interest rates could be beneficial if your monthly repayment decreases but can be a problem if it increases. Variable interest rates offer several other benefits often not available with fixed rate home loans like redraw and offset facilities and free extra repayments.
What happens to my home loan when interest rates rise?
If you are on a variable rate home loan, every so often your rate will be subject to increases and decreases. Rate changes are determined by your lender, not the Reserve Bank of Australia, however often when the RBA changes the cash rate, a number of banks will follow suit, at least to some extent. You can use RateCity cash rate to check how the latest interest rate change affected your mortgage interest rate.
When your rate rises, you will be required to pay your bank more each month in mortgage repayments. Similarly, if your interest rate is cut, then your monthly repayments will decrease. Your lender will notify you of what your new repayments will be, although you can do the calculations yourself, and compare other home loan rates using our mortgage calculator.
There is no way of conclusively predicting when interest rates will go up or down on home loans so if you prefer a more stable approach consider opting for a fixed rate loan.
What is the average length of a home loan?
Most Aussie lenders offer home loans with a 30-year term, meaning that you should pay back the full loan amount and the interest you owe on the amount in 30 years.
However, home loans can also have a shorter or longer term. They may be as low as ten years or up to 45 years, depending on the product and lender.
It’s worth remembering that a longer loan term usually means you’ll end up paying a lot more interest in total, but your scheduled repayments may be more manageable. In contrast, you could opt for a shorter loan term if you are comfortable making large repayments in exchange for paying less interest over the term of the loan.
What are the features of home loans for expats from Westpac?
If you’re an Australian citizen living and working abroad, you can borrow to buy a property in Australia. With a Westpac non-resident home loan, you can borrow up to 80 per cent of the property value to purchase a property whilst living overseas. The minimum loan amount for these loans is $25,000, with a maximum loan term of 30 years.
The interest rates and other fees for Westpac non-resident home loans are the same as regular home loans offered to borrowers living in Australia. You’ll have to submit proof of income, six-month bank statements, an employment letter, and your last two payslips. You may also be required to submit a copy of your passport and visa that shows you’re allowed to live and work abroad.
What do people do with a Macquarie Bank reverse?
There are a number of ways people use a Macquarie Bank reverse mortgage. Below are some reasons borrowers tend to release their home’s equity via a reverse mortgage:
- To top up superannuation or pension income to pay for monthly bills;
- To consolidate and repay high-interest debt like credit cards or personal loans;
- To fund renovations, repairs or upgrades to their home
- To help your children or grandkids through financial difficulties.
While there are no limitations on how you can use a Macquarie reverse mortgage loan, a reverse mortgage is not right for all borrowers. Reverse mortgages compound the interest, which means you end up paying interest on your interest. They can also affect your entitlement to things like the pension It’s important to think carefully, read up and speak with your family before you apply for a reverse mortgage.
Cash or mortgage – which is more suitable to buy an investment property?
Deciding whether to buy an investment property with cash or a mortgage is a matter or personal choice and will often depend on your financial situation. Using cash may seem logical if you have the money in reserve and it can allow you to later use the equity in your home. However, there may be other factors to think about, such as whether there are other debts to pay down and whether it will tie up all of your spare cash. Again, it’s a personal choice and may be worth seeking personal advice.
A mortgage is a popular option for people who don’t have enough cash in the bank to pay for an investment property. Sometimes when you take out a mortgage you can offset your loan interest against the rental income you may earn. The rental income can also help to pay down the loan.
Why does Westpac charge an early termination fee for home loans?
The Westpac home loan early termination fee or break cost is applicable if you have a fixed rate home loan and repay part of or the whole outstanding amount before the fixed period ends. If you’re switching between products before the fixed period ends, you’ll pay a switching break cost and an administrative fee.
The Westpac home loan early termination fee may not apply if you repay an amount below the prepayment threshold. The prepayment threshold is the amount Westpac allows you to repay during the fixed period outside your regular repayments.
Westpac charges this fee because when you take out a home loan, the bank borrows the funds with wholesale rates available to banks and lenders. Westpac will then work out your interest rate based on you making regular repayments for a fixed period. If you repay before this period ends, the lender may incur a loss if there is any change in the wholesale rate of interest.
When do mortgage payments start after settlement?
Generally speaking, your first mortgage payment falls due one month after the settlement date. However, this may vary based on your mortgage terms. You can check the exact date by contacting your lender.
Usually your settlement agent will meet the seller’s representatives to exchange documents at an agreed place and time. The balance purchase price is paid to the seller. The lender will register a mortgage against your title and give you the funds to purchase the new home.
Once the settlement process is complete, the lender allows you to draw down the loan. The loan amount is debited from your loan account. As soon as the settlement paperwork is sorted, you can collect the keys to your new home and work your way through the moving-in checklist.
What is a redraw fee?
Redraw fees are charged by your lender when you want to take money you have already paid into your mortgage back out. Typically, banks will only allow you to take money out of your loan if you have a redraw facility attached to your loan, and the money you are taking out is part of any additional repayments you’ve made. The average redraw fee is around $19 however there are plenty of lenders who include a number of fee-free redraws a year. Tip: Negative-gearers beware – any money redrawn is often treated as new borrowing for tax purposes, so there may be limits on how you can use it if you want to maximise your tax deduction.
What is break fee?
Break fees are charged when a customer terminates a fixed-rate mortgage. The amount is determined at the time you decide to break the loan and is based on how much your bank stands to lose by you breaking the contract. As a general rule, the more the variable rate has dropped, the higher the fee will be.
What is the amortisation period?
Popularly known as the loan term, the amortisation period is the time over which the borrower must pay back both the loan’s principal and interest. It is usually determined during the application approval process.
What is a honeymoon rate and honeymoon period?
Also known as the ‘introductory rate’ or ‘bait rate’, a honeymoon rate is a special low interest rate applied to loans for an initial period to attract more borrowers. The honeymoon period when this lower rate applies usually varies from six months to one year. The rate can be fixed, capped or variable for the first 12 months of the loan. At the end of the term, the loan reverts to the standard variable rate.