Refinancing to an interest-only loan can give you lower mortgage repayments and tax benefits for some investors.
Interest-only home loans allow you to repay the interest on a mortgage without making payments on the principal amount for a specified period, which can lower your monthly repayments.
However, there can be a greater risk in doing this because ultimately you will need to pay back the principal and delaying this means that your repayments won’t change until you start paying down that principal.
Most borrowers choose to refinance to an interest-only home loan when they are experiencing financial hardship or are building a home.
Many property investors also take advantage of interest-only refinancing especially when a property becomes vacant as this can help in terms of cash flow.
Interest-only home loan comparisons
When it’s good to refinance interest-only loans
Interest-only loans are suited to the specific needs of a certain few borrowers (and mainly property investors). Due to this, there are only a few situations when it's beneficial to refinance an interest-only loan. These are:
- Lower interest rates are available. Realistically, the main reason people refinance an interest-only loan is if interest rates have fallen and you are still paying a higher interest rate. With interest-only loans you pay only the interest, so any drop or rise in rates has a bigger impact than if you were paying the principal portion of your property off too. By refinancing to a lower interest rate loan, you may not only increase the interest-only period but reduce the repayments that you have to make.
- The interest-only period has ended. Another reason that you may want to refinance your interest-only loan is if the interest-only period is about to end, which for most loans is between 5 - 10 years. You may not be ready to start paying both the interest and the principal off, so refinancing the loan you can can allow you to just pay the interest portion.
- Your property value has increased. If your property's value has increased you'll have more equity and you might want to access it for a number of reasons. Staying with your existing lender is one option and selling the property is another, but you might also want to consider refinancing to a different lender in order to take advantage of better rates and features, especially if you plan to renovate or build a new property.
- Change your interest scheme. If you've decided to make the switch to a principal and interest loan, you might want to refinance. This may be because your existing loan won't offer you the features you want if you switch from interest-only repayments, or maybe a combination of the other factors above. If this is the case, make a good comparison of the loans available, as products can change over a short period of time.
- New features. Depending on how you plan to use your interest-only loan, you might want to refinance to enjoy different features or options. One such example is the ability to pay your interest in advance, usually offered on a fixed rate loan. The ability to do this means you can prepay the interest charges for the next year and claim the tax deduction for them this year, which can be useful for some investors. Contact an accountant to discuss whether or not this would suit your tax strategy.
How to find the best interest-only loan when you refinance
Once you've made the decision to refinance and are in the market to compare different home loans, consider these points:
Tell your lender you're going to leave
If you're leaving your existing lender for reasons other than finding a lower rate (e.g to find better features or because the interest-only period is coming to an end) this technique won't be as effective; however, sometimes telling your provider you're going to leave can net you an interest rate discount. This saves you the hassle of changing lenders and paying any fees involved with refinancing.
Get quotes from providers
Lender websites often only feature the main features of an interest-only refinance loan. To get the full terms and conditions of all the interest-only loans and to get an estimate on how much refinancing will cost you, approach your provider and request a quote.
How to compare interest-only home loans
Choosing an interest-only loan can be tricky, so it’s important to take time to compare the features on different loans to get one that suits your needs and to ensure that your mortgage is affordable. Here are the main features to use when comparing interest-only home loans:
- Interest rate. An interest-only loan can help you afford a more expensive home by allowing you to pay the interest portion of the loan for a period of about 5-10 years without repaying any of the principal amount. Once the period ends, you’ll have to start paying a high outstanding principal amount or refinance to another loan. It’s therefore important to shop around for an interest-only loan with relatively low interest rates to ensure the home loan you apply for is affordable. If you come across a lender offering lower interest rates, consider refinancing your current interest-only loan or standard mortgage to save more on interest repayments.
- Loan features. Interest-only loans with a longer repayment period and favourable repayment frequency can be easier to repay and they can put less pressure on your finances. Go for a loan with an interest-only period that suits you and a monthly repayment amount that you can easily service. Some lenders offer you the option of repaying your interest amount in advance as a lump sum, allowing you to save money and make tax deductions. A lender offering an interest-only offset account can allow you to reduce your interest repayments even further, depending on your savings.
- Loan fees. Like other types of mortgage plans, interest-only home loans can sometimes also have hidden fees, including agent fees, application fees and others. Most lenders will only disclose the main features of the home loan and hide other fees in the fine print. To ensure you get an affordable interest-only home loan, compare the terms of different interest-only loans and use a refinance calculator to compare costs on different loans.
Things to avoid with interest-only loan refinancing
Be mindful that you will eventually need to repay the principal loan amount at some point in time. The main reason why interest-only home loans are popular with property investors is because they generally intend to sell the property in the future and in the process pay back the principal.
However, if your interest loan is used for your personal property and you're refinancing to delay paying back the principal, it may be a good idea to speak to your lender for alternate options.
Refinancing any loan can be a long and complicated process and refinancing an interest-only loan is no different. Before deciding whether or not to agree to a refinance you should calculate whether or not it would be worth it. Once these steps are completed, start a comparison today.