I’m considering an interest only home loan – what do I need to know?

Interest only loans may seem like a great idea at the time – after all, why wouldn’t you want to have the lowest mortgage repayment possible? But is it really a good idea? As the name suggests, an interest only loan does not pay the balance back and only focuses on covering the monthly interest on the loan.

Investment property

If the property is for investment then this could be a really good strategy, as you minimize your monthly costs, as well as minimize how much of your own funds you put into the investment – you could use the savings in your cash flow to help cover any shortfall on your next investment, or just to enjoy life. As an investor you may be aware that interest on an investment loan is currently tax deductible, but the principal balance is not, so you have the added benefit of maximising how much you can claim for the year.

With this approach, as an investor, you’re really relying on capital growth for the investment while the rent covers are large portion of the holding costs.

Home owners

It’s a very different story if you are a home owner. Ideally you want to be reducing you non-tax deductible, non-investment debt as quickly as you can – so you really need to think about weather interest only is a good idea.

If you’re going through a period of financial adjustment, interest only repayments could provide some temporary relief. Perhaps you just lost your job, your hours have been reduced or simply have fallen behind on some others debts. Or perhaps you’ve just had a new addition to the family and have been reduced to one income for the next 12 months.

You might be trying to save or put money aside for others things, such as a large renovation to the home, or for a deposit for your next home.

There is any number of reasons why you might consider an interest only home loan on your home – but the key to remember is that during this time you may not be moving forward with your long term goals, and you do have to pay the loan off at some point. It’s important to understand that many banks may actually insist, at least at the time of loan settlement, that your owner occupier home loan is principal and interest.

It’s also important to understand how this may affect your repayments in future. If you’re on a 30 year loan term with principal and interest repayments, then your repayments are calculated over this time – if however, you take a 30 year loan term, with an initial 5 year interest only loan term – once that 5 years interest only period is over you now only have 25 years to pay the remaining balance. What this means is that your repayments are calculated over this time and thus you not only have a higher repayment, but have to demonstrate the bank you can also afford these higher repayments – so it could in turn affect your borrowing capacity.

If interest only is an option you are considering, first speak with a qualified mortgage broker about your requirements and then consider if an interest only home loan is right for you.