What is an Interest Only Loan and Should You Consider One?

You’ve probably heard them mentioned in advertisements, but what exactly is an interest only loan?

An interest only loan is where the borrower only pays the interest on the loan. This means they aren’t repaying the principal loan amount.

But why would somebody choose an interest only loan? Unsurprisingly, these types of loans are popular with investors who plan to make minimal repayments while their property’s value increases. Interest only loans are also sometimes used for negative gearing purposes.

Anyway, here’s the low down on the advantages and disadvantages of choosing an interest only loan.

What are the advantages of interest only loans?

So, you’re only paying the interest and not the principal amount, which means you’re probably saving some cash. These savings could be used to pay for other stuff – like investments or expenses.

Overall, with an interest only loan you’ll probably enjoy lower monthly repayments for a bit along with some financial flexibility. But be sure to triple check the terms and conditions before signing. While some lenders might allow you to make extra repayments to put toward the principal amount, this option may be limited when it comes to a fixed loan.

And if you’ve heard chatter about interest only loans being a way to maximise tax deductions, be sure to seek some professional advice from your accountant as everyone’s circumstances are different. Okay, let’s look at the not-so-sunny-side of things.

What are the disadvantages of interest only loans?

Okay, let’s look at the not-so-sunny-side of things.

If you get an interest only loan, you’re not reducing your mortgage during that period even though you’re making payments. Additionally, your equity in the property isn’t increasing during this interest only period – unless your property’s value increases.

Once the interest only period is up, you – and your wallet – may feel a bit surprised when you’re suddenly paying both interest and repayments on the principal loan amount for the remainder of the loan. The repayments are more than likely to be higher in this scenario, so consider preparing in advance for this change.

It’s also worth mentioning many lenders don’t usually offer interest only loans to owner-occupiers. Another drawback of interest only loans is you could be tempted to spend more money than you have, which is why you should speak to a mortgage broker before making a decision about any type of home loan.

Could an interest only loan be right for you?

As with everything else in life, there are two sides to consider before deciding about anything. While the advantages of an interest only loan are tempting, be sure to also consider the potential disadvantages. And if you need some expert advice on the matter, contact your friendly home loan specialist.

Navigating the home loan process is easier when you have a helping hand. If you’re looking for home loan and interest rate options, get in touch with Pania for some personalised mortgage advice.

Disclaimer: This is general information only and is subject to change at any time. Your complete financial situation will need to be assessed before acceptance of any proposal or product.