Interest-only home loans from 6.1%

What is an interest-only home loan?

An interest-only (IO) home loan does not require repayments of the principal borrowed amount for a specific period of time - the regular payments consist only of interest charges on the loan. Generally, the interest-only period sits between three and five years.

How do interest-only home loans work?

Interest-only home loan payments only cover the interest owed on the principal amount. This means you're not chipping away at the principal amount borrowed unlike a typical principal and interest (P&I) home loan.

After the interest-only period ends, your mortgage will shift back to a principal and interest (P&I) loan repayment structure. This means that the amount you are contributing will begin to pay off the principal, rather than just covering interest. Ultimately this means you will be required to make larger repayments, given you are now paying for both aspects of the loan (principal and interest).

Most borrowers opt for a home loan with principal and interest (P&I) repayments. These loans typically offer better interest rates than interest-only loans, plus they build equity in the home sooner - meaning there’s less principal for interest to be charged on over the life of the loan.

Who is best suited to an interest-only loan?

Interest-only loans tend to be particularly appealing to property investors more so than traditional home buyers. This is because investors rely on on limiting non-interest expenses to enable them to free up cash for other investments.

On the other hand, interest-only home loans can be beneficial to home buyers looking to manage a number of debts including car loans, personal loans or credit card debts. This is because interest-only mortgage repayments are typically lower, meaning a greater portion of finances can be placed towards paying off other debts.

It is important to note that while repayments may initially be smaller, you will likely end up paying more over the life of your mortgage given you accumulate more interest while not paying off the principal over the interest-only period, plus interest rates are typically higher for interest-only loans.

To calculate interest-only home loan repayments and to help determine whether this loan option may be suited to your financial position, check out our Interest-Only Home Loan Calculator.

Comparing interest-only rates

Pros and cons of interest-only mortgages

The decision to take out an interest-only mortgage should only be made after carefully considering the benefits and risks involved. Some of these are outlined below.

Interest-only pros

1. Lower repayments

Temporary lower repayments during the interest-only period could help you save more money for other expenses including renovations or pay off more expensive debts.

2. Investment Strategy

If you're an investor, you could claim higher tax deductions from an investment property. Investors may also look to sell properties within the interest-only period to reduce expenses.

3. Buying time

The reduced repayments effectively let people buy time through the delaying of higher repayments. Whether it be a temporary reduction of income or a temporary increase in expenses, if borrowers are confident of returning back to a level of income or expense ‘normality’ at the end of the interest-only term, then interest-only loans are a great way for them to effectively buy time and flexibility.

4. Alternative loans

An interest-only home loan may be useful for short-term loans, such as bridging finance or a construction loan.

Interest-only cons

1. Higher interest costs

Since you’re not paying off the principal over the interest-only period, you’ll end up paying more interest over the life of your loan than a borrower paying both principal and interest.

2. Higher interest rates

Interest-only loans often have a higher rate of interest than principal & interest (P&I) loans. This means paying more over the life of the loan. 

3. Repayment shock

If you’re not prepared, the expiry of an interest-only period can come as a shock as the costs of repayments suddenly increase. This is because you are paying nothing off the loan principal during the interest-only period. 

4. Less equity

If your property doesn't increase in value during the interest-only period, you won't build up any equity. This can put you at risk if there's a market downturn, or your circumstances change and you want to sell.

How long can you take out an interest-only loan for?

Interest-only periods usually last between 3 and 5 years. Some lenders offer interest-only periods of up to 10 to 15 years, but this may be restricted to investors. You may be able to negotiate the length of the interest-only period with your lender, depending on your personal circumstances.

What happens when interest-only loans expire?

When your interest-only loan period expires, your loan will roll over to principal and interest repayments. This means you’ll be paying off the outstanding principal as well as interest.

There are three main options you can pursue if your interest-only loan period is ending:

• Extend the interest-only period: Lenders will want to keep their customers and may be willing to extend your interest-only period. This will probably be subject to a credit assessment and property valuation.
• Refinance to another loan: If you’re nearing the end of your interest-only period, it might be a good idea to review your interest rate and finances before comparing other options in the market. Other lenders might be able to offer a better rate on a principal and interest loan than the rate of what your interest-only loan is rolling over to.
• Ride out the expiry: If you’ve planned well and you’re confident that you’ll afford the P&I repayments (and you’re happy with your interest rate), riding out the expiry of the interest-only period and transitioning to the P&I stage of your current home loan is the most hassle-free option at your disposal.

Interest only vs principal & interest repayments

The key difference between principal and interest and interest-only repayments is principal and interest loans pay off the actual loan principal right from the beginning. So the actual house you’ve borrowed all that money for is being slowly paid off, whereas interest-only loans only pay the extra interest costs.

The table below highlights the difference in monthly and total repayments of an interest-only and principal and interest home loan, based on the average home loan size of $610,000 over 30 years at an interest rate of 5.00% p.a. The interest-only loan term for this example is 5 years, meaning the remaining 25 years is with a principal and interest loan.

Savings.com.au’s two cents

Interest-only loans can offer great opportunities to build cumulative wealth from buying and selling property in rising markets. The flip-side to this opportunity is the risk that lies in getting caught when the market turns and profits do not materialise (or disappear).

In this (unexpected) situation, interest-only loans can harm wealth through increased repayments after the interest-only period and/or having to sell the property at a net loss due to values falling and an inability to service new larger repayments.

Interest-only loans can be a great short-term solution for property investors and owner-occupiers alike, but they tend to have more benefits for property investors, while owner-occupiers (outside of what might be described as extraordinary circumstances) are generally better suited towards a standard principal and interest loan.

Do your research and read the terms and conditions before making a purchase decision.