Interest only loan repayments start lower because you just pay off the interest. You pay more interest in the long run, but for the right borrower it can be a good option.
On this page you can find competitive interest only mortgages, get more information about these products and find out if they’re right for you.
How interest only loans work
Most mortgages are principal and interest loans. You borrow money and repay it, plus interest. The money you borrow is called the principal.
But with an interest only loan you just repay the interest on top, not the money you’ve borrowed. At first. When the loan reverts to principal and interest repayments, you have to repay both the principal and the interest together.
This means interest only loans start with much lower repayments. But over time they cost you more because you have to pay more interest.
They can be risky because the principal is the main part of the loan. If you’re not repaying the principal, you’re not really owning more of your home.
What are the risks and benefits of interest only mortgages?
- Lower repayments. Interest only loans are cheaper at first. If you’re struggling to make repayments this loan type can help, for a while. But in the long run they won’t.
- High-growth investment. Property investors in booming markets often use interest only loans. They buy a property, make small interest only payments and watch the property grow in value. Then they sell it for a big profit. They never need to repay the loan.
- Tax savings. If you’re an investor, your repayments may be tax-deductible, particularly if you use a 100% offset account. This is because interest on funds withdrawn from an offset account rather than redrawing from your loan are tax deductible.
But the risks are obvious.
- No equity. If your property doesn’t grow in value you don’t much of it if you’re not repaying the principal. You could end up in negative equity.
- Revert. Repayments will jump up when the loan reverts to principal and interest.
- Higher interest rates. These mortgages usually come with higher interest rates.
For the well-informed, well-organised borrower an interest only loan can work well. But if you don’t know what you’re doing it can get messy.
The interest only trap
Imagine you bought an investment property in 2016. For three years you made interest only repayments. You had trouble renting it out, but you were waiting for the property to grow in value.
But the market slowed and your property lost value. Then your loan reverted to principal and interest.
Now your repayments are much higher and your property is worth less. You haven’t paid off any of your loan and if you sell you’ll still in debt.
This is the interest only nightmare scenario.
Is it harder to get an interest only mortgage now?
Lenders are still careful when assessing interest only borrowers.
Maximise the chances of getting your application approved by:
- Saving a bigger deposit. Many banks are more willing to consider an interest-only mortgages if you have a lower loan-to-value ratio (LVR). A bigger deposit, usually at least 20%, will make you a more attractive borrower.
- Making a plan. Lenders will want to know why you want an interest-only mortgage versus a principal and interest loan. If you can explain your justification for the loan and demonstrate your investment plans, you’ll be in a much better position.
- Talk to a mortgage broker. A broker’s job is to help you find a loan that suits your needs and financial situation. The broker vets your application before the lender does, maximising your chances of approval. Get in touch with a broker today.