Cons of interest-only loans
Higher interest rates: Interest-only loans typically come with higher interest rates compared to fully amortizing mortgages. Lenders consider these loans riskier due to the lack of principal reduction during the interest-only period.
Interest only loans can be a good tool for an investment property because it can increase cash flow or reduce your out-of-pocket costs while you rehab the home and then refi to a traditional mortgage.
Whether it's a good idea to change your repayment mortgage to interest-only depends on your individual situation. If you're looking to pay less each month, then switching to interest-only can help you free up some cash from your paycheck to go towards other things.
An interest-only mortgage allows borrowers to reduce their repayments in time of need or may enable property investors, to claim tax benefits*, as the total interest repayment may be tax-deductible.
If you're interested in keeping your month-to-month housing costs low, an interest-only loan may be a good option. Common candidates for an interest-only mortgage are people who aren't looking to own a home for the long-term — they may be frequent movers or are purchasing the home as a short-term investment.
Interest-only repayments are available for a set period over the life of the loan. Up to 5 years on an Owner-occupied loan and 10 years on an Investment loan. Principal and interest repayments following an interest-only period will be higher than if you'd been paying both the principal and interest from the start.
There are several different ways they could extend your mortgage, including: turning all or part of it into a repayment mortgage, with a later agreed full repayment date. letting you repay it with several agreed payments rather than just one lump sum.
You'll make interest only payments towards your mortgage for six months, with no impact on your credit score. You can cancel at any point, but you can only apply once. Your monthly payments will increase at the end of the reduced payment period to collect the amount you haven't paid.
A typical interest only mortgage lasts between five and 25 years. It's possible to remortgage to a new deal at any time, which is often a good idea if interest rates have changed. You can also remortgage at the end of the deal – but you will need to meet affordability criteria.
Interest-only mortgages can be risky and expensive and are unsuitable for most borrowers. However, some people manage to make money by choosing an interest-only deal because their repayment plan returns more than they need to pay off the original loan amount.
Interest-only repayments
Once the agreed interest-only period ends, you'll start repaying your principal at the current interest rate at that time. As you're not making payments on the 'principal', this will remain the same, unless you choose to make additional repayments.
The lender will make an assessment based on your permitted income and expenditure. Other factors such as the number of dependents you may have will also be considered. Arranging your mortgage on interest-only will not necessarily mean you will be able to borrow more.
After the interest-only period, you have the option to refinance, pay a lump sum, or begin paying down the principal. However, it's important to note that your monthly payments will increase significantly once you start paying both the principal and the interest.
Pros. Lower repayments during the interest-only period could help you save more or pay off other more expensive debts. Short-term finance that covers the period between buying a new property and selling your existing property. A type of home loan for people who are building their own home.
The bottom line: Ultimately, you'll pay a premium for the privilege of making low, interest-only payments for a period of time. The appeal of an interest-only mortgage is the lower initial payments, but you'll need to balance those upfront savings with higher overall costs.
There's a higher risk of negative equity than a repayment mortgage. The mortgage balance remains the same over the mortgage term, leaving you more exposed to changes in house prices. The total amount paid in interest over the life of an interest only mortgage will also exceed the interest paid on a repayment mortgage.
Going interest-only likely wins if you need a significant amount of short-term help. That's because it generally reduces your monthly bills by a greater amount. HOWEVER, you pay for it in the long-run as it will likely add more to the total cost of your mortgage.
Paying less interest means you'll have more money to save or spend on other wants or needs. And it can make paying your monthly bills easier. But even if these are all good things for your personal finances, the interest rate on your accounts doesn't actually affect your credit scores.
Using your extra funds to pay off your mortgage reduces the amount of money you have for other expenditures. For example, you may need to build an emergency fund, pay off other high-interest debt, or buy a new car.
No Equity Growth: Interest-only mortgages generally require large down payments, so lenders have collateral against default. But for the first 5-to-10 years, the homeowner's equity doesn't grow at all, unless you make extra payments. If your goal is paying down a mortgage, interest-only loans are a bad place to start.
Overpayments on interest only parts of your mortgage won't automatically reduce your monthly mortgage payment, unless you ask us to, but could save you money by reducing the amount of interest charged.
An interest-only retirement allows retirees to live off the interest generated by their investments without touching their principal savings. Sounds pretty good, right? However, this approach requires careful planning and a sizable portfolio to generate sufficient returns.
The bank won't give you an interest only loan forever. Generally, the bank will approve an interest only mortgage for up to 5 years. So once you get to the end of your interest only period, you need to apply for another interest only period. But each bank has different policies.