When applying for a home loan, it's important to consider all your options and ensure the loan is the right one for you and your family. And as your circumstances and lifestyle change, your loan requirements may change as well.
The type of repayments you make is one of those important considerations - are interest-only or principal and interest payments right for you?
If you're an owner-occupier, principal and interest payments are the most common way to make repayments, but for some (especially property investors), making interest-only payments can have a number of benefits. Let's take a closer look.
The majority of home loans in Australia are principal and interest home loans. That means that each home loan payment includes a contribution toward:
Your other option is to make interest-only payments. As you'd expect, this type of payment only pays the interest charges of your loan, it does not reduce your loan's principal amount.
With an interest-only home loan, you'll pay only interest for a set term - usually between one and five years. After that interest only term runs out, your repayments will revert to principal and interest. In most cases this means your repayments will increase.
Structuring your home loan this way may have several benefits, but it's not without risks and drawbacks.
Repayments
Interest only home loans have lower repayments than principal and interest home loans during the interest-only period (because you are only paying interest, not principal).
However, when the interest only period ends and your loan reverts to principal and interest, your repayments will increase.
In fact, they will exceed what they would have been if you'd been making principal and interest repayments for your entire loan term. This is because you won't have paid off any of your principal balance during the interest only period. Therefore, the balance outstanding on the loan at the end of the interest only period will not have reduced from the start of the loan, compared to if you had been paying off principal the whole time.
Total cost
Interest-only home loans may be more affordable in the short-term, but they will likely cost you more across the total duration of your loan.
That's because, as discussed above, your loan principal remains unchanged for the entire interest-only period. Your interest amount won't start reducing until you start paying off principal and therefore the balance outstanding on your loan reduces, which in turn reduces how much interest you pay. To give you a clear picture of the potential cost difference, let's take a look at an example**:
*Interest only *Principal and interest Loan amount $500,000 $500,000 Interest only period 3 years N/A Monthly repayments during interest only period $1,038 N/A Monthly repayments during principal and interest period $2,121 $1,973 Total interest payable $224,617 $210,282
* Assuming an interest rate of 2.49 and a loan term of 30 years.
As you can see, the monthly repayments are much lower during the interest-only period, then slightly higher (compared to a loan without an interest only period) for the remainder of the loan term. More importantly, the total interest paid is over $14,335 higher for the loan with the interest-only period.
The risks of interest-only home loans
Interest-only home loans can help you manage your costs initially, however there are risks you may encounter if you're not careful when borrowing and planning for the future. A few common risks and pitfalls include:
If you're considering an interest-only home loan make sure you keep the above risks in mind and take steps to manage them.
Since 2017, over 80% of new home loan lending in Australia has been to borrowers making principal and interest repayments, according to CoreLogic data1. That's because, in most cases, it's better to make principal and interest repayments and reduce your loan amount each month, with the goal of eventually being mortgage-free.
With that said, here are a few examples of when an interest-only loan may be a smart option:
When applying for a home loan, it's essential that you take a close look at your circumstances, your lifestyle and your budget and design a mortgage that suits you. To get started and find out what type of loan is right for your circumstances, contact Qudos Bank's home loan specialists today.
1 Housing lending may be cheap, but regulators argue it is not yet risky (corelogic.com.au)
Qudos Mutual Limited trading as Qudos Bank ABN 53 087 650 557 AFSL/Australian Credit Licence 238 305. The information in this article is of a general nature and has been prepared without considering your objectives, financial situation or needs. Before acting on the information, consider its appropriateness to your circumstances.
Normal lending criteria, terms and conditions and fees and charges apply. Mortgage insurance is required for home loans over 80% and is subject to approval.
Interest only subject to approval. During an interest only period, your interest only payments will not reduce your loan balance. This may mean you pay more interest over the life of the loan.
You should read and consider the relevant Terms and Conditions and our Financial Services Guide available on our website qudosbank.com.au, before deciding whether to obtain any of our financial products or services.
** Disclaimer about results from example:
The results displayed in the example in this article should be used as an estimate only. Results do not represent either quotes or pre-qualifications for a loan. Qudos Bank may not provide loans with the details indicated in the example. The specific details of your loan will be provided to you in your loan contract. We have made a number of assumptions when producing the calculations, including:
Published July 2022
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