Considering an Interest-Only Home Loan? What to Know

Interest-only loans may seem like an appealing choice – after all, lower mortgage repayments are attractive. However, as the name suggests, an interest-only loan does not pay down the principal balance and only covers the monthly interest.

Investment property

If the property is an investment, this can be a strategy to minimise monthly costs and reduce the amount of personal funds tied up in the investment. Savings in cash flow could help cover a shortfall on another investment or assist with daily expenses. Interest on an investment loan is generally tax-deductible, whereas the principal balance is not, which may help maximise allowable tax deductions.

With this approach, an investor relies primarily on capital growth while rental income covers a large portion of the holding costs.

Homeowners

It is a different story for owner-occupiers. The general goal is usually to reduce non-tax-deductible debt as quickly as possible, so whether an interest-only period is suitable requires careful consideration.

During a period of financial adjustment, interest-only repayments can provide temporary relief. Examples include job changes, reduced working hours, managing other debts, or adjusting to a single income after welcoming a new family member.

Some borrowers may also look to set money aside for other purposes, such as a major home renovation or a deposit for a future property.

There are many reasons to consider an interest-only loan, but during this period, progress on long-term loan reduction pauses, and the balance must still be repaid eventually. Many lenders may also insist that an owner-occupier loan is principal and interest at settlement.

It is also important to understand how an interest-only period affects future repayments. On a 30-year loan term with an initial 5-year interest-only period, the remaining balance must be paid off over the remaining 25 years. This results in higher repayments after the interest-only period ends, and lenders will assess whether these higher repayments are affordable, which can affect borrowing capacity.