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.
For first-time home buyers, an interest-only mortgage also allows them to defer large payments into future years when they expect their income to be higher. However, just paying interest also means that the homeowner is not building up any equity in the property—only the repayment of principal debt does that.
Flexibility: Interest-only loans offer you more choice in how you want to make your mortgage payments — you can stick with interest-only payments or choose to make additional principal payments during the interest-only period to reduce the principal balance and lower future monthly payments.
This is because, in effect, you're only paying the interest charges on your mortgage loan. If someone has a short term need to preserve money, they could choose this, retain the mortgage and property and just service their interest-only loan before switching back to a repayment mortgage.
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. If you're looking to buy a second home, you may want to consider an interest-only loan.
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.
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.
If you have an interest-only mortgage, you need to make plans to repay the capital (the amount you borrowed). If you don't, you will have a large amount to pay at the end of your mortgage term and may need to sell your home to repay it.
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.
An Interest Only mortgage only requires monthly interest payments. Since you are not paying any principal, this can lower your monthly payment. However, since your mortgage's principal balance is not decreased, you will have a balloon payment at the end of the mortgage's term.
A balloon mortgage is a home loan with an initial period of low or interest-only payments. The borrower pays off the balance in full at the end of the term. A balloon mortgage is usually short-term, often five to seven years.
Disadvantages of an Interest-Only Mortgage
Interest-only mortgages are high risk - get it wrong and you can be stuck with an expensive loan that costs more than you get in return. If circumstances change before the term expires and these affect your ability to re-mortgage, things can get messy.
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.
Generally, for most homeowners, a repayment mortgage is the better option. You'll pay less interest over time and your home is yours as the end of the deal.
Advantages of an interest-only mortgage
Lower monthly payments, as you are only paying back the interest on your loan. Greater control over your investments, meaning you can decide how you save to repay the capital of your mortgage.
There are also risks involved with getting an interest-only repayment loan. For example, if your home or investment property declines in value during the interest-only period, you could come out with no equity. Meaning, you may end up owing more than the property is worth.
Overpayments directly reduce the outstanding loan balance, making the final repayment amount smaller or potentially allowing you to pay it off entirely before the term ends. When making overpayments, please be aware that you may have to pay an early repayment charge to your lender (if applicable).
It is possible to switch your mortgage to an interest-only basis if you have sufficient equity in your property, an acceptable repayment plan and meet the lender's income requirements.
There are limits to how long you can have interest only periods – the maximum interest only period at any one time is five years for owner occupiers and 10 years for investors (credit criteria applies). Interest only is not available in the last five years of your loan.
A line of credit is a good example of an interest-only loan. Because there are no principal payments, the monthly servicing requirements are low. They can also be paid back and then “redrawn” (meaning borrowed again) without penalty, making them highly flexible.
👎 Drawbacks of Interest-Only Mortgages
With interest-only, you're only paying to borrow, not own. So, unless the market adds value to your home, you won't be building any equity. If prices drop, you could even end up owing more than your home's worth – a bit like paying rent but with a big bill waiting at the end!
If an early repayment charge doesn't apply then you can overpay as much as you like (without paying off your mortgage in full) without being charged.
Interest only mortgages are available for home buyers, although they're not as common as repayment mortgages. To get one, you'll need a plan in place to repay what you owe when the mortgage ends. As with any other mortgage, whether you're approved is at the lender's discretion.