An interest-only mortgage is best suited for high-net-worth individuals, real estate investors, or borrowers with irregular income streams who prioritize maximizing short-term cash flow over immediate equity building. It is ideal for those planning to sell or refinance within 5-10 years, or those expecting a significant income increase.
An interest-only mortgage starts with payments that only pay down the mortgage interest. Generally, this makes your monthly payments lower than a typical mortgage payment. This option is attractive for those who cannot afford high mortgage payments.
While an interest-only loan may sound appealing for people looking to keep their payments low, it can be more difficult to get approved and is typically more accessible for people with significant savings, high credit scores and a low debt-to-income ratio.
The biggest drawback of an interest only mortgage is that you don't pay off the loan as you go. This means you have to find another way to do this – you can't just forget about it. Another downside of an interest-only mortgage is that the total amount you repay over time will be much higher than a repayment mortgage.
One major risk is that your monthly payments could increase significantly at the end of the interest-only period when you are required to start paying both principal and interest. Additionally, if your property's value decreases, you could find yourself underwater on your loan — owing more than the property is worth.
What are the benefits of interest-only mortgages? Some people like the flexibility to be able to make lower payments initially, and pay more when their income or savings increase near the end of their mortgage term.
People with fluctuating income also like interest-only loans because they can make the interest-only payment when they're short of funds, and pay down the principal when they have more money like a bonus or commission payment.
An interest-only mortgage payment on $200,000 depends on the interest rate, but at 5%, it's around $833/month (just interest), significantly lower than principal & interest payments, though you never build equity and pay more total interest over time, with later payments including principal. For example, at 3.25%, the initial payment is about $542/month for the interest-only period.
Interest-only mortgages used to be easy for banks to resell to other financial institutions. That's no longer the case. Today, this loan type is seen as higher risk. As a result, mortgage lenders often charge higher interest rates than they do for fixed-rate mortgages.
Important things to consider
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.
You can pay off your interest only mortgage early, but there may be limitations to the amount you can repay without incurring an Early Repayment Charge (ERC), depending on your mortgage. Check your mortgage terms for more information on repayments limits or charges.
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It might be more difficult to get accepted for an interest-only mortgage, as they're often viewed as higher risk. If you get to the end of your term and your repayment vehicle hasn't performed and doesn't cover the lump sum, you'll either need to sell your home or find another way to repay.
Short-term savings: Renting is cheaper than buying in the short term because you don't need a big down payment or lump sum to buy a house. Moving flexibility: You have much more flexibility with changing your home and moving around. This is great for individuals not set on living in the same place for years to come.
An interest only home loan may be suitable if you're looking for:
With interest-only mortgages, you only pay off the interest on the amount you borrow. You use savings, investments or other assets you have (known as 'repayment plans') to pay off the total amount borrowed at the end of your mortgage term.