An Interest Only loan is a loan repayment method where you only pay the interest on the loan for an agreed period of time (generally between 1 & 5 years).
When only the interest on a loan is being paid the loan balance, or principal amount outstanding is not being reduced. The idea sounds confusing to many borrowers given that if a home loan is never paid off you could never own your home outright.
There are however a number of sound reasons as to why a borrower would want utilise this loan feature.
For many investors home loan interest payments on an investment loan will be a tax deductible expense.
Most investors will have a mix of deductible and non-deductible debt to pay off. For this reason it makes sense to repay the minimum amount on tax deductible debt and direct all spare cash to paying down non-deductible debt. Non-deductible debt may include the home loan for the house you live in, or other personal loan/credit card expenses.
It’s best to speak to a tax professional such as your accountant prior to altering or entering into a new loan structure or property investment. The above is not intended to be used as tax advice.
Some lenders will allow you to borrow more when your loan repayments with other lenders are interest only as your monthly commitments will be lower. Consider the example of a $400,000 home loan over 30 years at an interest rate of 6.00%:
The extra $398.20 that needs to be paid back can make a large difference to your current & future borrowing capacity.
Very few lenders assess investment loan applications in this way. An experienced mortgage broker who understands the importance of this can assist in helping you leverage your property portfolio.
Whilst interest only repayments are generally used by investors there are occasions when it can be advantageous for an owner-occupier to use.
If you are taking out an interest only loan for an owner-occupied property most lenders will want to know the reasons why before approving your loan.
If you have other debt at higher interest rates it may be worthwhile considering reducing the repayments on your mortgage to focus on paying down the higher interest debt. Examples of higher interest debt may include personal loans or credit cards.
Depending on your home equity position you may also wish to consider debt consolidation.
If you plan to turn your home into an investment property at a later stage it may be worthwhile considering interest only repayments from the start. This can help preserve future tax deductibility on your interest repayments.
A loan structure that includes a 100% offset account is generally recommended to help reduce interest payable.
There is a vast variety of differences between banks & lenders when choosing interest only repayments. Some of these include:
If you’re considering an interest only loan and are unsure if it’s appropriate for you we would be happy to discuss the pros and cons as it relates to your situation.