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.
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:
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.
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:
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:
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:
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:
You should compare several options before choosing an interest-only home loan. Here are some examples of market interest-only home loan rates:
Loan provider | Loan type | Interest rate | Comparison 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% |
Loan provider | Loan type | Interest rate | Comparison 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 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.
Interest-only home loan - 1-year interest-only period | Interest-only home loan - 5-year interest-only period | Principal & 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 | ❌ |
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:
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:
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.
PROS
CONS
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.
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.
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.
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.
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.
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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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.