So what is an interest only loan?
Interest only loans were originally created for property investors and allow the borrower to repay only the interest component on the loan – that is, to repay the interest charged but to avoid paying the principal (the loan amount) back. This type of loan offers many of the same features of standard a loan but is geared towards investors as they have much lower monthly repayments, giving property investors the chance to have an affordable, tax-deductible investment whilst making property available to those looking to rent. Property investors use this type of loan with the hopes that the property will go up in value and that they can then sell it for profit, an appealing option for many looking to put their money to work for them. For investors, the money saved from making repayments towards the principal can be invested into something with a higher return than the interest charged on the loan.
However, in recent years, skyrocketing property prices and rising interest rates have made interest only home loans more popular in Australia for owner-occupiers, especially those struggling with higher interest rates as a way to minimise monthly repayments. Others favour interest only loans when they are trying to purchase a property that is slightly above what their current budget will allow in terms of loan repayments. Interest only loans can also be a viable option for people looking to renovate their property, or those looking at building a new property. If you choose this route, you must remember that you don’t have the benefit of gaining equity in your property if you are only paying the interest.
Interest only loans are not considered a long term strategy and generally last for 5 to 7 years before selling the property or refinancing the loan. If your plan is to use the money saved to ‘make ends meet’ and to pay for necessities in life like paying bills and feeding your family, then an interest only loan is certainly not recommended.
Advantages
- Lower repayments means you can have greater cash flow to invest or use to renovate
- Makes purchasing residential investment properties a more affordable wealth creation strategy for those trying to pay off their own place of residence
Disadvantages
- Once the interest only period is over, the loan immediately reverts to a principal and interest arrangement – so the repayments will increase right away
- You can only borrow an amount you can afford to repay under a principal and interest scenario, to ensure you can still service the loan once the interest only period is complete
