Question: I am a new home buyer considering taking up an interest only loan. If I take an interest-only option for the first 10 years and then the loan reverts to principal and interest repayments will I be better off? Or is it better to stick with a normal principal and interest loan for the whole time?
Answer: The real costs associated with interest-only deals are often overlooked, especially by first-time borrowers who are looking for the least expensive loan structure in those tough early years of home ownership. The truth is you have to be extremely disciplined and have the right loan structure if you’re going to come out in front with an interest-only deal. Don’t go into any interest-only deal unless you’re confident you can (and your lender lets you) make extra repayments and the loan comes with a free redraw facility.
And before signing on the dotted line, use an online calculator to check what your repayments will increase to at the end of the interest only period. After the initial 10 year interest-only period you only have 20 years to repay your whole principal. As a result you’ll find the principal and interest repayments for the duration of the loan are substantially higher than if you’d stuck with a 30-year principal and interest loan structure.
For instance, on a $300,000 loan, the interest only repayments for the first 10 years would be a comparatively low $1410 per month but from the start of year 11, they’d jump to $2087.46 per month. If you’d stuck with a P&I loan for 30 years, your monthly repayments (assuming an interest rate of 5.64% and no extra repayments) would be $1729.81. Going interest-only means taking a punt that rates will stay relatively low, your living expenses won’t increase too much and your wages will.
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