Q. Can you tell me about interest-only loans and over what period borrowers can simply repay interest, and not the principal amount of a loan?
A. Interest-only loans are popular with investors as they allow them to claim continuing large tax deductions by way of negative gearing. Only paying interest on a loan means that less of the investor’s cashflow is tied up servicing the loans and can be used for other purposes. Some lenders now don’t require any principal repayment for 20 years, although a five-year period is still the most common. Most lenders now also offer loans on which one year’s interest can be paid in advance, thereby allowing the investor to bring forward the tax-deductible interest payments. These loans provide some limited year-to-year flexibility as to the timing of interest deductions, which can lead to a smoother income pattern and lower taxation. Some lenders provide a discount of around 20 basis points on fixed-rate loans on which interest is prepaid.
Often first homebuyers will also seek an initial interest-only period to reduce their cash flow commitments while they’re setting up home. Even though you may be interest-only you’re generally able to make additional partial repayments if you wish without penalty.
Related: Home Loan Calculator