The Pros And Cons Of An Interest Only Loan

The Pros And Cons Of An Interest Only Loan

There are two different types of loan repayments you can select when taking out your home loan. These are Principal and Interest or Interest Only Loans.

You should definitely do your research, as well as getting professional advice, before making a decision, however some of the pros and cons are set out below to help you in the decision process.

What Is An Interest Only Loan?

Firstly, you should understand what interest only loans are. As the name suggests, when you select interest only repayments, you will only be paying the interest on your home loan. You can generally apply for an interest only period of between 1 and 5 years, but some lenders are offering up to 15 years.

Pros

1. Maximise Your Cashflow

When you make interest only repayments, your repayments are significantly lower during the interest only period. This is because you are not paying off any of the loan principal. This can free up cashflow for things other things.

But keep in mind that after the interest only period is finished, you will revert back to paying the principal too. As you will be repaying the entire loan principal over a shorter period of time, your repayments will be considerably higher. This may also be a good time to consider refinancing.

2. Flexibility

As you have a much lower commitment, you will have more money left at the end of the month and greater flexibility around what you do with it. If you were making principal & interest repayments, you would be forced to pay down the debt against the property.

Interest only allows you the flexibility of parking the extra cash in an offset account, applying it to other debts, or possibly utilising it as a deposit for your next property.

3. Same Loan Features As Principal And Interest

The good thing is that interest only repayments can be selected on loans which include the same loan features as a principal and interest loan, including offset accounts, extra repayments, etc.

Cons

1. Loan Balance Does Not Reduce

As you are only paying off the interest, the actual loan balance will not reduce. When the interest only period ends, your loan will then revert back to principal and interest repayments, which will lead to significantly increased repayments. So it is important to make sure that you can afford the increased repayments before taking out the interest only option.

2. What If Property Prices Drop?

If property prices drop and you have only been paying the interest over, say, 5 years, you may find yourself between a rock and a hard place if you have to sell. As you have not paid down any of the actual debt, if you sell the property at a loss you will need to find funds elsewhere to pay off the remaining debt.

It is worth keeping up to date on how much your property is worth before making a decision like this. A property report can give you an estimate on how much your property is worth in today’s market.

3. You Must Be Disciplined

You really do need to be disciplined with interest only loans. If the extra cashflow is not being utilised correctly and just being used for your everyday expenses, it might be an idea to change to principal and interest repayments to ensure you are reducing your loan balance.

However if you are disciplined and utilising this extra money for other investments or requirements, it may be worth considering an interest only repayment.

Remember, It is always best to contact a good mortgage broker or financial adviser to ensure you have all of the information required before making a decision on what repayments you should go with.

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