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09 Aug, 2022
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A typical home loan repayment consists of two parts:
With an interest-only home loan, mortgage holders are only required to pay off the ‘interest’ part of the loan, rather than the principal and interest (P&I) for an agreed period of time, usually between three to five years.
For some borrowers, having an interest-only home loan is a suitable way to ease themselves into the loan by making the bare minimum repayments. What this means is that your home loan balance won’t reduce during the interest-only period since you’re technically not paying off the amount you borrowed. Additionally, interest rates for interest-only home loans tend to be higher than P&I home loans.
If you’re considering an interest-only loan, you’ll want to do some research to find out all the elements involved and ultimately whether it’ll suit your needs and circumstances.
Like anything, an interest-only home loan doesn’t last forever.
When the time comes, your interest-only loan will automatically roll over to P&I repayments. This means you’ll start paying off the amount you borrowed as well as the interest.
There are three options you can follow if your interest-only loan period is ending.
1. Extend the interest-only period: If possible, your lender may be willing to extend your interest-only period to keep you as a customer.
2. Get ready for P&I repayments: If you’re ready to make the switch to P&I repayments, ride out the expiry of the interest-only period and settle into P&I repayments with no hassles.
3. Refinance: Maybe you’ve done some research and seen a better rate on the market. If so, you might want to look at refinancing your home loan with your current lender or a potential new one to take advantage of any beneficial features.
On average, lenders offer interest-only periods between three to five years. However, if you have a chat with your lender, they may be able to offer you up to 15 years but this is generally reserved for investors.
What are the benefits and disadvantages of an interest-only home loan?
No matter what type of home loan you decide to take out, it’s always a good option to weigh up the pros and cons involved. Below is a list of some of the benefits and risks you could encounter when taking out an interest-only home loan.
To show you the difference between the two payment types, we’re going to compare how much interest a mortgage borrower would pay for an interest-only loan versus a principal and interest loan.
For example, John Smith decides to take out a home loan of $500,000 for 30 years.
For the purpose of this comparison, it’s assumed John’s interest rate is 3.00% p.a which holds steady over the 30 years for both the interest-only loan and the P&I loan.
For the interest-only loan, John opts to pay this for five years before switching to P&I for the remaining 25 years.
John Smith (P&I) |
$500,000 |
N/A |
$2,108 |
$758,887 |
John Smith (Interest-only) |
$500,000 |
$1,250 |
$2,371 |
$786,317 |
Total cost difference |
N/A |
N/A |
$263 |
$27,430 |
As shown above, by paying an interest-only loan for the first five years, John’s loan will cost him over $27,000 more than the P&I loan over the 30 years.
Generally, lenders tend to charge higher interest rates on interest-only home loans compared to P&I loans.
If you’re unsure whether an interest-only loan or principal and interest loan will work best for you, compare the interest rates that are available on the market with both payment types.
To get you started, check out our handy comparison table above with some of the best interest-only loans on the market. Or, insert all the relevant information (loan amount, loan term, payment type) into our mortgage repayment calculator to find out your estimated repayments, the total principal paid, and the total interest paid. From there, you can make a decision regarding whether interest-only or principal and interest repayments are the right option for you.
Not sure which type of loan is best for your needs?
Your Mortgage can help you find out.