Compare options and consider whether an interest-only loan could be a tax-savvy option for you.
APRA's March clampdown on interest-only lending may have made the market tougher, but options are still out there for borrowers suited to these loans.
Interest-only loans differ from standard home loans in the way they're repaid. Traditional principal and interest home loans have repayments that include both the interest and a small proportion of the principal. Interest-only home loans, on the other hand, repay only the interest portion of the loan for a fixed period, usually up to five years. While you make interest-only repayments you won't be reducing the principal, but you will reduce the size of your monthly repayment.
Some of the loans below feature interest-only repayments. The rate advertised might not be reflective of the interest-only rate.
Compare interest-only home loans
Rates last updated August 20th, 2017.
- HSBC Home Value Loan - Resident Owner Occupier only
Application fee waived for Resident Owner Occupier only.
February 15th, 2017
- Bank Australia Basic Home Loan - Variable (Owner Occupier)
Interest rate increased by 0.08%
February 20th, 2017
- IMB Budget Home Loan - LVR <=90% (Owner Occupier)
Comparative rate increases by 0.10% | Interest rate increases by 0.10%
April 5th, 2017
Interest-only home loans explained
Hear the industry experts (listed below) share some thoughts around interest-only loans:
- Kim Wight | Sydney Mortgage Broker
- Neil Manuel | Former eMoney General Manager
Click here for video transcript:
Carla Baldock: An interest-only loan is where your monthly repayments only pay back the interest on the loan that you've taken out. So, in other words, at the end of the loan, home loan period, typically 30 years, your balance of your home loan is still due. All you've paid is the interest on
Stuart Tucker: Interest-only loans are often used sometimes for investors, who just want to be able to measure the interest component of that loan, and also for people in the early term of their, say 25 year loan period, just to give them a kick start, and then after a period of time, start paying down principal and interest.
Kim Wight: With interest-only loans, they're predominantly for the investor, because when people are buying an investment property, they're doing it (1) for capital growth, and (2) for being able to get a tax advantage in negative gearing. And the only, the portion that is a tax advantage is the interest rate.
Neil Manuel: So the main benefit of an interest-only loan is that the balance actually doesn't get reduced. You're only paying the monthly interest on a loan. Why is that important, is because on an investment property, you can claim more back from your interest payments when the balance of the loan is actually higher. So the lower you bring the balance down, the less you are able to claim back, because you're being charged less interest.
About interest-only loans
Interest-only home loans are loans that only require you to pay the interest portion of the repayments. This means you pay less each month than a regular principal and interest loan.
For many, it’s an option that requires financial discipline and looking for a short term solution.
"When we recommend an interest-only, variable rate product, we are referring to the minimum repayment amount as the interest component," says Andrew Tan, co-founder of Masters Broker Group*. "Care needs to be taken, and it is important that borrowers understand the key difference between a principal and interest repayment and an interest-only repayment. A borrower making an interest-only repayment must not develop the mindset that they are meeting their entire borrowing commitments, as no principal repayments have been made."
Who are interest-only loans suited to?
Interest-only loans can be an option for some investors. Investors will usually use interest-only loans to purchase a property and make minimal repayments. Many investors use this strategy because interest payments on an investment home loan are tax deductible. Investors choose interest-only home loans to minimise their monthly repayments while maximising cash flow and tax effectiveness.
According to Mr Tan, borrowers that are good with money could benefit from the flexibility that an interest-only loan could provide because it "allows the borrower to pay more than the interest, allowing the borrower to make principal repayments even when the loan is interest-only. This is great to manage cash flow and provides options for the borrower".
There are also other perks associated with an interest-only loan if you have the right financial advice.
"When used with tax planning, the borrower can keep the repayments on an investment loan at the minimum amount, and direct additional funds to non-tax deductible borrowings, like a home loan," explains Mr Tan.
Why might an owner-occupier choose an interest-only home loan?
One of the only reasons for an owner-occupier to choose an interest-only home loan is to minimise monthly repayments. This is why lenders often dissuade owner-occupiers from taking out interest-only home loans. If you can't handle the full principal and interest repayment of a home loan, odds are you've borrowed more than you can afford.
While some owner-occupier borrowers might choose an interest-only period while acclimatising themselves to making regular home loan repayments, it pays to be wary of this strategy. You won't be making headway on paying down your debt, and your repayments could rise dramatically when the loan reverts to principal and interest.
What's the best interest-only home loan?
There's no one best interest-only home loan, as our circumstances are all different. There are different ways you can find out if a home loan is the right one for you. These include comparing one or more of the following:
- Fees. You might be looking for an interest-only home loan with low upfront and ongoing fees.
- Interest rates. Interest rates are slightly more important when comparing interest-only home loans as there's no principal repayment, meaning the full amount of your interest repayments will rely on the interest rate you're paying.
- Features. Many borrowers opting for interest-only home loans also opt for 100% offset accounts, as they can be used to realise tax savings. Other features such as the ability to make extra repayments, bring your loan with you to a new property, or split your loan into fixed and variable portions might be important.
What are the risks of interest-only loans?
Industry experts reveal the risks of interest-only home loans.
Key points to consider
- Another consideration of this loan type is if the borrower has continued to make the minimum interest-only repayments and hence not contributed anything towards the principal loan amount, they will not have built up any equity to access for other means, unless the property has increased in value.
- Interest-only loans are popular among investors. This is generally because the interest on a loan may be tax deductible depending on your personal situation. As the interest on an owner-occupied property loan is not tax deductible, it’s generally better to pay this down as quickly as possible. In saying this though, there are cases where interest-only loans for owner-occupied properties may be appropriate as part of an overall financial strategy, for example when using the extra funds elsewhere such as paying down more expensive debts, or using the funds for renovations instead of borrowing additional money.
- The main risk of an interest-only loan is that you are not required to make any repayments on the principal loan amount. Over the long term, the balance of the loan will remain high and as a result, the interest requirements will be higher.
Connect with Stuart: view his blog
Should I split my interest-only home loan?
A split rate home loan will see your home loan split into different portions. These portions can be fixed for different periods of time like a regular fixed rate home loan or left as variable rates. The benefit of this is that you can get some of the advantage of a variable rate home loan, such as interest rates which can decrease over the course of a year, with some of the advantages of a fixed rate home loan, like protecting yourself from rising rates.
Note that some home loans will only allow for two splits e.g they allow you to split the loan into two portions. Others allow you to split your loan into as many as five or even six portions.
Interest-only home loans pros and cons
As mentioned above, there are a few considerations involved with interest rates, and a number of advantages.
- Lower repayments. With an interest-only mortgage, you'll have lower repayments compared to a comparable principal and interest loan. This is because you're not paying the principal aspect of the home loan.
- Tax savings. If you're an investor, your repayments may be tax-deductible, particularly if you use a 100% offset account. This is because interest on funds withdrawn from an offset account rather than redrawing from your home loan are tax deductible.
- Need to refinance. Interest-only periods generally last about 5 years, after which you might have to refinance to another lender if you wish to continue making interest-only payments
- Market risk. There can be higher risk than principal and interest loans as you're not building equity in the property, meaning if property values decrease you could end up owing more than your property is worth. Also, if interest rates rise you could be paying more for the same value property.
How a mortgage broker can help
Interest-only home loans are getting more difficult for borrowers to get following APRA's 30% cap on new interest-only lending. If you've researched your options but you're still not sure whether an interest-only home loan might be right for you, it could be time to talk to a mortgage broker.
*Disclaimer: The article is for general information purposes only. The use of interest-only loans should be considered in the context of your overall investment strategy, financial situation and needs. You should, before acting on this, consider its appropriateness to your circumstances.