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Interest-Only Home Loans

Written by

Shaun McGowan

Interest-only home loans are a type of home loan where the borrower only makes repayments of the interest accrued on the principal borrowed amount. While this can enable lower repayment amounts, there are risks associated with interest-only home loans that every borrower should be aware of.

How do interest-only home loans work?

Interest-only home loans work by structuring repayments to only cover interest accrued on the principal amount. Repayments on an interest-only home loan will generally be lower than repayments on a comparable principal and interest home loan.

This is because repayments are made up of two key components:

  • The principal - the amount borrowed for the home loan
  • Interest - charged by the lender based on the principal amount and rate

With interest-only home loans, your repayments will only cover the interest accrued, and will not reduce your principal amount.

Interest-only home loans will only be offered for a set period of time, generally between six months and 10 years. At the end of the interest-only period, your home loan will revert back to principal and interest repayments.

Learn more about home loan fees and repayment options.

Interest only Home loans

Interest-only home loan benefits

In some circumstances, an interest-only home loan can be a good idea if you’re aware of all the risks from the get-go. Here are a few of the most common examples.

Interest-only home loans for owner-occupiers:

  • Construction loans - During construction of a new home when costs are high borrowers may benefit from lower repayments until construction is complete.
  • Bridging finance - If you buy a new home before you sell your current property lower, interest-only repayments may ease the financial burden of covering two mortgages and property purchase costs temporarily.
  • Need extra income - If your circumstances change and your household’s income decreases (for example, after the birth of a child) interest-only repayments can provide temporary relief.
  • Need to pay off other debt - If you have other debt with higher interest rates than your home loan, such as credit cards or personal loans, switching to lower interest-only repayments temporarily may free up finances to repay that debt.

Learn more about construction home loans.

Interest-only home loans for investors

  • Tax benefits - Home loan interest and some investment property expenses are tax-deductible. If your investment is negatively geared (making a loss) you may be able to claim that loss against other taxable income to reduce your tax bill.
  • Reducing cash flow & waiting for capital gains - Investors use this strategy to buy a property, make interest-only repayments, then resell the property for a profit. This is a risky strategy; if the property decreases in value over time, however, the mortgage may exceed the property value.

Learn more about investment home loans.

Investment Property Home Loans

Interest-only home loan disadvantages

Interest-only home loans can be an easy way to achieve lower mortgage repayments, however they also come with significant drawbacks and risks, which you should be aware of before you choose one:

  • You won’t pay off your loan’s principal at all during the interest-only period.
  • Your home loan may take longer to repay and you’ll pay more interest over the life of your loan.
  • Your property may decrease in value during your interest-only period - if this happens your loan amount may end up exceeding the value of your property.
  • When your interest-only period runs out, your loan will revert to principal and interest repayments and your repayments will increase, which can cause financial hardship.
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Due to the risks and drawbacks of interest-only home loans, you should always seek impartial expert advice before choosing this loan type.

Switching from interest-only to principal and interest repayments

One of the biggest risks with interest-only loans is the increase in repayment amount that occurs when the loan reverts to principal and interest at the end of the interest-only period.

To prepare for your repayment amount to increase after your interest-only period ends you can:

  • Make sure you’re aware of when your repayment will increase and by how much when the loan reverts to principal and interest.
  • Make room in your budget to accommodate the extra cost a few months in advance of when your repayments switch.
  • Save money during the interest-only period if you’re able. This may help to ease the financial pressure when your loan reverts to principal and interest repayments.
  • Talk to your lender and ask for support in advance of the switch to principal and interest repayments if you can’t afford the repayment increase.
  • Consider extending your interest-only period or refinancing your loan.
Principle and interest home loans
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In some cases, your repayment amount may double or more, which can cause significant financial strain if you’re not prepared for it.

Applying for an interest-only home loan

Getting approved for an interest-only loan can be more difficult than for a principal and interest loan. That’s because interest-only loans are generally considered to be riskier by lenders.

To make your application as strong as possible you can:

  • Save more. If you have a large deposit then your bank will view you as a less risky borrower. Aim for at least 20%.
  • Justify your choice. If you have a clear and reasonable justification for applying for an interest-only loan your lender may look at your application more favourably.
  • Consider alternatives. If you’re unsure whether or not your bank will approve your interest-only home loan application, engaging a mortgage broker or non-bank lender may improve your chances.

Learn more about applying for a home loan.

Compare interest-only home loans

You should compare several options before choosing an interest-only home loan. Here are some examples of market interest-only home loan rates:

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Owner-occupier interest-only home loan comparison

Loan providerLoan typeInterest rateComparison rate

Commbank

1 year fixed rate - interest-only

3.54%

4.60%

ANZ

1 year fixed rate - interest-only

3.93%

4.40%

NAB

1 year fixed rate - interest-only (Choice package)

3.89%

4.46%

Westpac

1 year fixed rate - interest-only

4.09%

5.20%

Investor interest-only home loan comparison

Loan providerLoan typeInterest rateComparison rate

Commbank

1 year fixed rate - interest-only

3.04%

5.07%

ANZ

1 year fixed rate - interest-only

3.94%

4.85%

NAB

1 year fixed rate - interest-only (Choice package)

2.79%

4.82%

Westpac

1 year fixed rate - interest-only

2.99%

5.06%

Interest-only home loan cost comparison

Interest-only home loans may have more affordable payments at first, but the total cost of the loan is usually much higher due to increased interest. It may also take longer to repay your loan.

Comparison

Interest-only home loan - 1-year interest-only periodInterest-only home loan - 5-year interest-only periodPrincipal & interest home loan

Loan term

30

30

30

Loan amount

$500,000

$500,000

$500,000

Interest rate

3%

3%

3%

Regular monthly repayment

$2,118

Monthly repayment during interest-only period

$1,260

$1,260

Monthly repayment after interest-only period

$2,163

$2,163

Monthly fees

$10

$10

$10

Total interest cost over the life of the loan

$267,834

$289,917

$262,487

Additional interest cost over the life of the loan due to interest-only period

$5,346

$27,430

Summary

Interest-only home loans may be a great idea for some, but they can be risky and expensive. The main benefit of interest-only home loans are lower repayments in the short term, but there are also several drawbacks:

  • Higher interest rates
  • The principal amount stays the same
  • Higher total interest cost
  • Payments increase after reverting to principal and interest

In some cases, these risks are worthwhile, if you have a clear plan and can afford your repayments when your interest-only period ends. Examples of when an interest-only loan might be useful include:

  • Construction loans
  • Bridging loans
  • Temporary change in circumstances or a drop in income
  • Paying off other, higher interest debts
  • Investors holding property while waiting for capital gains

If you’re not sure whether or not an interest-only home loan is right for you, speak to an expert financial advisor to make sure you understand what’s involved. Interest-only loans are a tool that can be useful as long as you’re aware of the costs and implications from day one.

Interest-only home loans pros and cons

PROS

  • Lower repayments during the interest-only period
  • May have tax benefits for some investors
  • If your loan is on a variable rate you may still be able to make principal repayments but you are not required to
  • May free up cash to be invested elsewhere

CONS

  • Your loan principal amount does not decrease during the interest-only period. If your home decreases in value your mortgage amount could exceed the value of your home
  • Interest rates are usually higher with interest-only home loans
  • After your interest-only period ends your repayments will increase as they revert to principal and interest.
  • You may end up paying more interest over the life of the loan, and you may take longer to repay your home loan if you choose interest-only
  • Interest-only loans are riskier than principal and interest loans. It may be more difficult to get loan approval. 

Interest-only home loans FAQs

What are interest-only home loans?

An interest-only home loan is a loan that only requires you to make interest payments during a fixed period of time. When that fixed period ends your repayments will revert to principal and interest.

Are interest only home loans good for property investment?

In some cases interest only home loans may be suitable for property investors. That’s because they have tax benefits and decrease the cost of holding property while it increases in value. Investors should always talk to an expert for advice before securing an interest only home loan as they can be risky and expensive.

Who offers interest-only home loans?

All of the big four banks (ANZ, NAB, Commbank & Westpac) and most other lenders offer interest-only home loans. That includes mortgage brokers, non-bank lenders and mutual banks.

How do I apply for an interest-only home loan?

To apply for an interest-only home loan contact your preferred lender or visit their website. In some cases, you may be able to complete your application online.

How much deposit do I need to apply for an interest-only home loan?

To apply for an interest-only home loan you will usually need a deposit equal to 5% of the property value, although it’s usually better to have more than 20% in order to avoid extra fees like lender’s mortgage insurance.

Are interest-only home loans more expensive?

Interest-only home loans tend to include higher interest rates than principal and interest home loans. Rates may also be higher for investors than owner-occupiers.

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About the Author

Shaun McGowan from money.com.au

Shaun

McGowan

Shaun McGowan

Shaun is the founder of Money.com.au and is determined to help people pay as little as possible for financial products. Through education and building world class technology. Previously Shaun co-founded CarLoans.com.au and Lend.

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