Compare interest-only home loans

What is an interest-only home loan?

Interest-only home loans are popular among property investors and borrowers who want to lower their mortgage repayments over the short term. This type of repayment structure only requires borrowers to pay off the interest on their loan, as opposed to both the principal (the amount you borrowed) and the interest you accrue. 

However, interest-only mortgages aren’t without their drawbacks, and they may prove a more expensive option over the long run.

How do interest-only home loans work?

With an interest-only home loan, you only pay for the interest that builds up in your mortgage repayments – you won’t be paying off the principal amount you borrowed to buy your property. 

While this means your repayments will be lower than a principal and interest home loan for the duration of your interest-only period, it could mean you end up spending more money on your home loan by the end of it. This is because you haven’t chipped away at the original amount of your home loan. 

Are interest-only home loans more expensive than principal and interest loans?

Let’s look at an example of the difference in monthly repayments and total interest paid on a $500,000 home loan over 25 years. The rate for this loan is 7.00% p.a. and the interest-only period lasts 5 years.

In the example above, an interest-only loan ends up costing the borrower $36,152 more at the end of the loan, despite having lower mortgage repayments for the first 5 years. 

Who are interest-only loans good for?

Due to their low-cost repayments, interest-only loans are usually favoured by property investors who prefer to have spare cash handy for other ventures. But, plenty of owner-occupiers take out interest-only loans for similar reasons, like freeing up cash to pay off credit card debts. 

Pros and cons of interest-only home loans 

While the big advantage of interest-only home loans is temporarily lowering your mortgage repayments, it’s important to also understand the risks involved. 

Pros of interest-only home loans

• Lower initial repayments. The amount you’ll need to pay back over the interest-only period will be lower than it would be if you opted to make principal and interest repayments.
• Tax incentives for investors. If you’re a property investor you may also be able to benefit from tax deductions associated with the interest-only repayments made on an investment loan.

Cons of interest-only home loans

• Higher rates. Lenders tend to charge an interest rate premium to both owner occupiers and investors on interest-only loans, so it’s worth taking that into account when comparing your options. 
• You’ll have to make up the repayments. While you may be making lower payments during the interest-only period, once that period finishes your repayments are likely to jump.
• You might not build equity. While your home equity might increase if your property’s value rises, interest-only repayments won't chip away at the loan’s principal, so you might be more vulnerable to a fall in equity, or even negative equity, if values drop. Negative equity is a huge problem if you decide to sell because you return a loss.

What happens after my interest-only home loan expires? 

As most interest-only loans last between 3 to 5 years, you’ll need to come up with a plan for what you’ll do after the interest-only period expires. 

Usually, you’ll be rolled onto a principal and interest home loan, meaning you’ll be playing catch-up with your unpaid loan amount, leading to potential ‘bill shock’ from rising repayments. 

Instead of being rolled on to higher repayments, try: 

• Negotiating an extension on your IO period. Lenders typically want to keep you on their books and may agree to extend your interest-only period.
• Refinancing. As interest rates change all the time, it might be worth your while to compare home loans and see if you can reduce the amount you would otherwise pay by sticking to your current loan. Compare refinance rates.