Compare interest only home loans

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Compare interest only home loans


The ins and outs of interest-only loans

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. 

For more information on interest-only loans, read the FAQ below. 

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 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. 

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. Here are three ways you could use that extra money to your advantage: 

  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. 

  1. 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