20 May Interest only loans: Are they worth it?
This week the Sydney Morning Herald reported that Commonwealth Bank would be tightening their lending restrictions again. Up until now, home buyers have been able to take out interest only loans.
On the surface they can look pretty good because you only need to pay the interest for a period of time, but are they really all they’re cracked up to be?
If you’re not sure, we’ve done the research for you so you don’t have to, however we do welcome questions and one of our experts would be happy to answer any questions you may have.
Some of you may be wondering what an interest only loan is. To answer that question is very simple. It is exactly as it sounds. You only pay the interest on the home loan for a period; normally of five or seven years, and then once the time has lapsed, you would refinance with the view to start paying the principle of your loan.
So with that knowledge of the technical side of an interest only loan, what are some of the pros and cons?
Who doesn’t want a lower payment on their accommodation? You’d be hard pressed to find someone who would say no to that question. It seems like a draw-card on first glance, however in reality, lower repayments today means you have higher repayments tomorrow. It could also increase the likelihood that you will find yourself over committing.
Typically interest only mortgages are favoured by investors because it means they can split their funds and potentially buy more properties than they would be able to if they were paying the principle of the loan as well. As an investor that’s great because it means an investor can buy a property they otherwise couldn’t.
The downside to that though is that although the payments are lower, there’s the potential that an investor will over commit themselves and will not actually be able to sustain their mortgage should they be required to pay the principle as well.
It’s risky because if a home borrower is only paying the principle then if there was a property crash they wouldn’t be able to draw out any equity and that could mean that they owe more than they did when they first took out the loan. The downside of that is it has the potential to destroy someone’s financial position and could increase the likelihood that they will need to declare themselves bankrupt if something was to go wrong with the property market. It would also pose an issue if they needed to sell the property during a property slump.
Lack of equity
Your Mortgage reports the story of someone who took out an interest only loan. They were hoping to sell the property and make a profit. Unfortunately for them, property prices didn’t increase like they thought they would so they ended up making a loss. An interest only loan has the potential to restrict buying capacity in the future because equity hasn’t been built up. It may be hard to pay an extra $100 – $300 a week, however there are options for mortgage holders willing to do that. They could take on a second job or they could get in a tenant if they do not use all the rooms.
Interest only loans can be incredibly dangerous and it’s much better to consider the future before you take out a home loan. If you’re unsure of anything, it’s really important to talk to a trusted financial professional. The team at Aspirus would be more than happy to answer any questions you may have about home loans or investment lending.