What is an Interest Only Loan?

Interest Only Loan

What is an Interest Only Loan?

Most home loans are what is known as principal and interest, which means you pay off both interest and the actual debt itself.

There is also the possibility of taking out an interest only loan, whereby you only pay off the interest. On the surface, this might not seem like a good idea because you’re not making any inroads on the debt. However, there are situations where an interest only loan is a good idea 

The best thing to do is to speak with your mortgage broker in Melbourne so they can assess what your goals are and see if an interest only loan is right for you.

Advantages and Disadvantages of Interest Only Loans

The most obvious advantage of an interest only loan is simply that your repayments will be lower.

If you’re only paying back interest and no principal, then your weekly repayment is going to be lower. This in itself can be greatly beneficial.

Lower repayments might be important if you’re on a very tight budget and it also might allow you to borrow more money than you could have otherwise because your ability to service the debt is slightly better.

On the flip side, interest only loans are not as easy to come by as they once were. In fact, if you’re an owner occupier, it might actually be quite difficult to get approved for an interest only loan.

Interest only loans are largely targeted at investors and unless you have a good reason, many of the major lenders only offer P&I loans to owner-occupiers.

Another consideration is that an interest only loan will often come with a slightly higher interest rate than a traditional variable P&I loan. If you think about it from the perspective of the lender, if a borrower is not paying down any principal, they are taking on a slightly higher level of risk and therefore you would expect to pay a slightly high interest rate.

While an interest only loan might actually lower your repayments, because the interest only loan attracts a higher rate, the savings might not be as significant as you had hoped.

The other important element to note with an interest only loan is the fact that they remain interest only for a set period of time. In most cases that will be only four or five years – after which, they will revert to a normal P&I loan anyway. It is possible to refinance to another interest only loan, but you will have to go through the application process again.

If you are intending on using an interest only loan and then letting it revert to a standard P&I loan, you might find that you end up paying more interest over the life of the loan anyhow.

One thing that is worth noting, is that in the current environment, there are a number of lenders that have very competitive introductory offers that mean even a P&I loan is going to be a very compelling proposition.

If you need to save some money in the early stages of your home loan, then the best course of action might be to look for an introductory offer. Again, the best course of action is to speak with your mortgage broker in Melbourne as they will be able to work with your goals and find the most appropriate loan for your situation.

Generally speaking, interest only loans are an investor product, but fortunately, if your goal is to lower your repayments, letting your mortgage broker shop around for you might be equally as valuable.

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