Interest-Only Home Loans Explained

If you’ve ever heard the term ‘interest-only home loans’ and wondered if it would suit your circumstances, then keep reading! Interest-only home loans have become more popular in recent years because they are often seen as a way to keep repayments a bit lower in the early stages of home ownership. With house prices at record-high levels across the country, it gives people the opportunity to purchase a house in a more financially manageable way.

With that said, these types of home loans aren’t for everybody, and you need to consider your individual circumstances before choosing a home loan product. Here’s everything you need to know about interest-only home loans

What is an interest-only home loan?

An interest-only home loan requires that you only need to make repayments towards the interest on your home loan for a set period of time. As an example, a regular home loan may have monthly repayments of $2,000. There will also be an interest charge of $900 for the month. Effectively, this means you’re paying the interest plus $1,100 towards the principal loan amount.

In an interest-only home loan, you would only be required to pay $900 per month to cover the interest charge. It’s important to note that interest-only home loans are only offered for a set period of time, usually 5 years. After that, you revert to a normal home loan.

How interest-only home loans work

The example above illustrates the repayment differences for an interest-only home loan, but let’s dig a little deeper.

Regular home loans are known as Principal and Interest home loans. This means your monthly repayment covers the interest owed, as well as paying off some of the principal. By paying something off the principal each month, you’re effectively also reducing the interest owed. This is because interest is calculated on the total amount outstanding.

With an interest-only home loan, you’re not contributing anything to the principal amount. So, while repayments will be lower for the first 5 years, you’re not necessarily making a dent in the principal. Ultimately, this means you’ll end up paying more interest over the life of the loan, however, the repayments will be more manageable in the early stages.

Pros and cons of interest-only home loans

Pros

The major benefit to an interest-only home loan is the fact that you have lower repayments in the first 5 years. This means you have more money available to do other things, such as renovations, alterations, or even just for regular expenses.

For investors, there may also be some tax benefits to an interest-only home loan. Again, investors have more money available to either increase the home’s value or consider other investments during the interest-only period.

Cons

Interest-only home loans can be a little risky for a number of reasons. Firstly, you’re not paying anything off the principal during the first 5 years. This means you’re not building any equity, and should you need to sell the home, there’s no guarantee you’ll even sell it for enough to pay out the mortgage.

Secondly, you end up paying more interest over the life of the loan. But perhaps most importantly, at the end of the 5-year interest-only period, the monthly repayments will increase significantly as you revert to a standard home loan. This can be a big shock to your lifestyle if you’ve become too comfortable with the lower repayments.

Who should consider an interest-only home loan?

There are a couple of occasions where you can really benefit from an interest-only home loan.

Firstly, property investors. As mentioned, there can be some tax benefits and if you want to sell the home within the interest-only period, you can do so for a profit, especially if you’ve used your extra available money to increase the home’s value.

Secondly, if you’ve still got other debts you’re trying to manage, such as credit cards or personal loans, it can be helpful to have that 5-year interest-only period at the beginning of your mortgage to pay down those other debts.

How a mortgage broker can help

If you’d like to know more about interest-only home loans, or other alternatives that may suit your circumstances even better, it pays to speak to a mortgage broker. Here at BrokerCo, we’re not linked to any specific banks and we work for you. That means searching far and wide to find the home loan products that truly suit your needs. Contact us today if you’d like to find out more about how we can help you find the perfect home loan.