Compare interest only home loans

Find home loans from a wide range of Australian lenders that best suit your needs, whether you're investing, refinancing or looking to buy your first home. Compare interest rates, mortgage repayments, fees and more. - Data last updated on 24 Oct 2018

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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 Principal-and interest loan Interest-only for 5 years Interest-only for 10 years Interest-only 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. 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 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.

  1. 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:

  1. Advertised rate
  2. Revert rate
  3. Fees
  4. Comparison rate
  5. Features

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.

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.

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.

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.

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.

How do you take out an interest-only loan?

There are three ways you can take out an interest-only loan:

  1. Use a comparison site (like RateCity)
  2. Go through a mortgage broker
  3. 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 Principal-and-interest loan Interest-only for 5 years
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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^Words such as "top", "best", "cheapest" or "lowest" are not a recommendation or rating of products. This page compares a range of products from selected providers and not all products or providers are included in the comparison. There is no such thing as a 'one- size-fits-all' financial product. The best loan, credit card, superannuation account or bank account for you might not be the best choice for someone else. Before selecting any financial product you should read the fine print carefully, including the product disclosure statement, fact sheet or terms and conditions document and obtain professional financial advice on whether a product is right for you and your finances.

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