The interest-only mortgage option is an attractive choice for borrowers who would like to enjoy lower repayments for a certain period of time. This home-loan option is appealing to two groups of property buyers: investors and first-home buyers.
First-home buyers often get interest-only loans to help them manage and adjust their finances as they settle into homeownership. Interest-only loans allow investors to take advantage of taxation benefits.
How interest-only loans work?
There are two components to a mortgage repayment: the principal amount of your loan and the interest charges. If you are on an interest-only loan, your regular repayments will only cover interest charges for a certain period, which usually lasts for up to five years. Over the interest-only period, the principal amount of your loan remains untouched.
When your interest-only period ends, your loan will revert to a principal-and-interest loan, which means that your repayments from then on will be higher. It is only then that you will be able to start repaying what you actually owe.
What are the benefits of interest-only loans?
1. Enjoy lower repayments
Whether you apply for an interest-only loan or you switch to interest-only payments, you will be able to trim the amount of your repayments. As mentioned earlier, your repayments over the interest-only period only cover the interest charges.
Here's an example: for a $425,000 mortgage over 25 years with an interest rate of 2.85%, your principal-and-interest repayments will approximately be $1,982 monthly. You can use this formula to estimate your monthly interest charges:
Loan Amount x Mortgage Rate / 12 months = Monthly Interest Charges
Using the formula above, here's how much you are going to pay monthly if you decide to go interest-only for the first five years of the loan:
$425,000 x 2.85% / 12 months = $1,009.38
Your Mortgage has an online tool that can help you calculate your repayments.
2. Take advantage of tax deductions
Interest-only loans allow investors to maximise their tax-deductible expenses. Given that the interest charges on investment loans are tax-deductible, investors often get interest-only loans to claim higher tax deductions.
With lower repayments, investors are able to free up extra money that they can use to pay the mortgage on their own home or fund other investments. They can also use the extra fund to non-tax-deductible personal loans.
3. Manage expenses
Interest-only repayments allow first-home buyers to adjust their finances and manage their expenses during the first few years of the loan. The interest-only period provides these buyers with the necessary breather after paying the costs and fees involved in the home-buying process and loan application.
Before you get an interest-only loan…
You have to remember that without proper planning, an interest-only loan could actually put you in a difficult situation in the long-run. At the end of your interest-only period, you will be paying significantly more, and if you are not able to use the period to take care of your other financial commitments, then you could end up in a debt trap.
Reach out to a mortgage professional to help you plan ahead before you get an interest-only loan. Visit Your Mortgage Broker to speak to our home loan specialist.