Interest-only fixed rate home loans can be less expensive loans in the short term, as you only repay the interest portion of the home loan repayment. This means you don't pay any amount towards the principal each month, and you have repayment certainty, because your interest rate doesn't change.
The down side? With an interest only loan, you're not repaying any of the debt. If you take out a $500,000 IO loan and make repayments for two years, then after two years of interest-only repayments, you'll still owe $500,000.
These home loans may not seem to make sense at first (who wants to make repayments on a debt that never goes down?!) But, they actually serve a solid purpose for a really specific type of borrower: usually an investor, or an owner-occupier who needs to lower their repayments for a while. After the table of options, let's dive into how these loans work and how to apply for them.
Interest-only home loans are mortgages that require you to pay only the interest on the amount you have borrowed, rather than paying off the principal amount in instalments each time you make a repayment. If you have borrowed $500,000, your monthly repayments will be lower on an interest only repayment than on a regular home loan contract, where you pay off the principal amount as well as the interest.
The repayments are much lower with an IO loan, as you can see – in our example above, it's less than half. This means you'll pay almost $1,000 less per month, or $12,000 less per year.
But, the flip side to that coin is, at the end of one year, the full amount of $500,000 would still be owing. With the P&I loan, you would have chipped away at $12,000 of the debt by then. Your home loan balance would be repaid down to $488,000, so you're making progress towards owning your home outright.
A fixed interest rate loan allows you to budget precisely each month, as the amount you are required to pay back never changes.
This can make monthly repayments easier to manage, especially if your interest-only repayments are being made on a property you are not yet living in (such as a home that's under construction).
Fixed rate interest-only home loans are short-term home loan contracts that only usually last for one to five years.
The important thing to know about interest-only home loans is that they are only available for short periods of time, as the bank eventually wants to see you make some headway with the principal. Think about it this way: if you had an interest-only home loan forever, you'd never own your own home. They are not recommended as a method to help you pay for your mortgage and afford your everyday living expenses.
| Response | |
|---|---|
| 3 yrs | 29.96% |
| 2 yrs | 26.87% |
| 1 year | 12.78% |
| 5 yrs | 12.78% |
| 4 yrs | 12.33% |
| More than 5 yrs | 5.29% |
Interest-only home loans are traditionally tailored for and suited to investors who plan to sell after only a short period of time and whose personal financial situation doesn’t necessarily benefit from paying off the principal borrowed amount. However, interest-only home loans are becoming more popular with people who might benefit from a short period of substantially lower repayments, including:
Make use of home loan comparison tools and calculators to see how the banks and lenders measure up to each other.
While it might seem like a great idea at the time, interest-only home loans should be taken out with caution and there are some pretty significant disadvantages to be aware of before you sign up.
The most glaring downside is that you are not actually paying off your home. This means that you are not building equity, and at the end of the loan period you are essentially where you started.
Another problem with fixed rate interest-only home loans can be that once your interest-only period is over, the amount you will need to pay in monthly instalments will actually increase. This is because the principal amount will not have changed and nor will the loan term, meaning that the same amount will have to be paid back in fewer instalments.
If you are using an interest-only home loan to bet on an investment, a lot rests on your ability to pick the market. While we do have a relatively stable property market here in Australia, real estate can be full of surprises. If you get it wrong you are looking at higher monthly repayments, paying more money in interest over the life of the loan or even losing money.
If you think you are eligible and would like to apply, you will need to provide documents to prove your case to your bank or lender.
When you are considering entering the property market for the first time or as an investor, it pays to ask lots of questions and shop around to find the home loan that suits you, your lifestyle and your financial requirements.
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