The cons of an interest-only loan
With an interest-only loan, you aren't building equity on your home until you begin making payments towards the principal. You can lose existing equity gained from your payment: If the value of your home declines, this may cancel out any equity you had from your down payment.
Interest-only mortgages offer attractive benefits, such as lower monthly payments and increased cash flow for investments. However, they also come with significant risks, including the need for a large lump-sum payment at the end of the term and limited availability.
Lower Initial Payments: The most immediate advantage is that interest-only loans require lower payments during the interest-only period, as you are not required to pay down the principal. This can be advantageous for properties that need renovations or have lower occupancy rates initially.
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.
Cons of interest-only loans
Lenders consider these loans riskier due to the lack of principal reduction during the interest-only period. Payment shock: Once the interest-only period ends, the monthly payments will increase as you start paying both principal and interest.
The interest rate could be higher than on a principal and interest loan. So you pay more over the life of the loan. You pay nothing off the principal during the interest-only period, so the amount borrowed doesn't reduce. Your repayments will increase after the interest-only period, which may not be affordable.
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.
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.
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.
If you want to make principal payments during the interest-only period, you can, but that's not a requirement of the loan. You'll usually see interest-only loans structured as 3/1, 5/1, 7/1, or 10/1 adjustable-rate mortgages (ARMs).
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.
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).
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.
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.
Yes; offset accounts can be linked to interest only loans. By keeping funds in an offset account, you can benefit from reduced interest expenses while enjoying lower monthly repayments during the interest only period.
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.
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.
You can switch between Principal and Interest repayment and Interest Only payment options during the life of your loan. However, there are limits for how long you can have Interest Only periods. These limits apply when you request a new or extended Interest Only payment.
Advantages to Interest Only Loans
Tax Deductible – The interest you pay on a mortgage is a tax deduction which saves you money on your income taxes. Be sure to consult a licensed tax professional for any tax deductions you may be eligible for.
Benefits of an interest-only mortgage
The most obvious benefit of an interest-only mortgage is that monthly payments are initially considerably lower than of typical loans. These loans allow the borrower to make larger purchases that they would otherwise only be able to afford a few years down.
The monthly repayments work out cheaper than they would on a capital repayment mortgage for the same amount of borrowing, as you're only repaying the interest... ...but the overall, long-term cost will be much higher. That's because you're not actually reducing the debt each month, meaning more interest accrues.
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.