Interest-Only Loans: What they are and when to consider one.

Interest-only loans can sound like (and be) a great option for some homebuyers. But are they right for everyone?

It all comes down to what your bigger picture is. This post aims to provide insights into the pros and cons of interest-only loans.

What are interest-only loans?

Interest-only loans are a type of mortgage where, for a set period, your repayments cover only the interest accrued on the loan amount. So during this period, your repayments will be lower, but you won't be reducing the principal amount of the loan.

I didn’t even know that was an option. How does it work?

In an interest-only loan, the initial period—usually ranging from 5 to 10 years—requires you to make payments that solely cover the interest accrued on the loan amount. Because you're not paying down the principal, your monthly payments will be relatively low compared to a standard amortising loan, where both principal and interest are paid.

Once the interest-only period ends, the loan "resets," and you will start making higher monthly payments that cover both the principal and the interest. This is known as the amortisation period of the loan. Since you haven't been paying down the principal during the interest-only term, these payments can be significantly higher because you'll have less time to pay off the same loan amount.

What are the pros and cons of an interest-only loan?

The benefits:

Lower monthly repayments: which can mean more cashflow and disposable income during the period.
Financial Flexibility: The saved money can be used for other investments or necessities.
Potential Tax Benefits for Investors

The Risks:

Higher Long-Term Cost
No Equity Buildup: Since you’re not paying off the principal you don’t build home equity during the investment-only period unless the home appreciates in value.
Risk of Unmanageable Repayments Post Interest-Only Period: The monthly repayments will be higher when the period ends.

How do I know if it’s right for me?

Interest-only loans are definitely not for everyone.

They’re generally best suited for:

Investors: Real estate investors may opt for interest-only loans to maximise tax deductions.
High-Income Earners with Variable Cash Flow
Those with variable income might find an interest-only loan appealing because it offers lower payments during lean periods.
If you plan on selling your home before the interest-only period ends, this could be an option for you.

Things to Consider Before You Apply for an Interest-Only Home Loan

It really comes down to what your long-term plan and strategy is. If you’re looking to buy your first family home, or forever home, it’s potentially not your best option.

However if you’re looking to start or build a property portfolio paying interest-only could be advantageous.

Speak to the experts.

Our team at IDEAL Financial is experienced in navigating the complexities of various loan options, including interest-only loans. We offer personalised guidance tailored to your unique situation, helping you make an informed decision.

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