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.
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.
While interest-only repayments are lower during the interest-only period, you'll end up paying more interest over the life of the loan. There are also risks involved with getting an interest-only repayment loan.
If you want a monthly payment on your mortgage that's lower than what you can get on a fixed-rate loan, you might be enticed by an interest-only mortgage. By not making principal payments for several years at the beginning of your loan term, you'll have better monthly cash flow.
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.
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.
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.
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.
Interest-only mortgages reduce the required monthly payment for a mortgage borrower by excluding the principal portion from a payment. Homebuyers have the advantage of increased cash flow and greater support for managing monthly expenses.
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 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.
Can you pay extra off an interest-only mortgage? If you're thinking about how to pay off an interest-only mortgage, it's worth noting that many interest-only mortgages allow you to make overpayments on your loan. This can be done as a lump sum or through increased monthly instalments.
Can I get an interest only mortgage? 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.
Interest-only mortgages aren't available to just anyone. Lenders often view them as riskier, so the qualifications are stricter. The ideal borrower for an interest-only mortgage usually: Has strong credit (typically a FICO score above 700).
The main reason people choose interest-only mortgages is to reduce the amount they have to pay out every month. If you can afford the monthly payments on a repayment mortgage, that is usually the better choice.
An interest-only mortgage is a home loan that has very low payments for the first several years that only cover the interest owed — not the principal. These lower initial payments may last for as long as 10 years, but after that you're required to start making payments toward the principal balance.
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.
The problem
With interest-only mortgages, the borrower makes no capital repayments on the loan, just interest. They are expected to have an investment plan in place to pay off the debt but some of these plans have been underperforming, while some borrowers never even set them up.
With an interest only mortgage, however, each month, you are only required to repay the monthly interest your loan has generated, and you don't need to repay any of the loan itself.
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.
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.
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.
At the end of an interest-only mortgage, borrowers must repay the entire loan amount. Options include paying a lump sum, selling the property, remortgaging, or arranging extended repayment with the lender. Planning is crucial to avoid financial challenges and potential property repossession.