What are interest only loans?
Most home loans are principal and interest loans, which means that making regular payments will reduce the amount you have borrowed (the principal) as well as go towards paying off the interest on your loan. However, with an interest only loan, you will only be paying off the interest for a set amount of time. So, what's the catch?
Pros and cons of interest only loans
You repay only the interest on the principal during the interest only period; therefore, repayments are lower than with a standard principal and interest loan. At the end of the interest only period - usually one to five years - you must start making Principal and Interest Repayments over the remaining term of the loan.
Pros:
- Lower repayments initially so you have more money to renovate/improve the property.
- Cuts the cost of buying a residential investment property in the short-term, which could allow you to make greater contributions to your principal place of residence.
Cons:
- There will be sudden increase in repayments at the end of the Interest Only period and the loan converts to Principal and Interest repayments.
- Lenders will assess your ability to repay the loan only on the principal and interest repayments. This can reduce your borrowing power, as these repayments will be higher than a loan on Principal and Interest for the full term.
