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Principal and Interest Loans

If you’re considering applying for a principal and interest home loan, this is the essential information you need to know.

Principal and Interest Loans

You might’ve heard the term “principal and interest loan” in the past, but not known exactly what it was or how it was different to standard home loans. You can read more about principal and interest loans, what they are, how they work and why they might be right for you in this comprehensive guide.

What is a principal and interest home loan?

As the name suggests, principal and interest loans are created by two separate factors: principal and interest.

Principal

The principal of your mortgage is the sum of money that you have borrowed from your lender to purchase your property. Your deposit will go towards the balance of the principal.

Interest

The interest is the money that your lender will charge you on the principal, for borrowing that amount. Interest rates will vary from lender to lender and will increase on a larger loan amount.

Principal and interest repayments are the most common type of home loan in Australia. This kind of loan involves repayments that are made on both the principal and the interest from day one. Generally, principal and interest home loans will be repaid over a 30-year term.

How should I compare principal and interest home loans?

Fortunately, you have a variety of factors to take into account when separating the best principal and interest home loans from the worst. No two lenders are the same when it comes to their rates, fees or policies, so dive deep into the home loan research process! We’ve compiled a table below of some of the areas you should look at when you compare principal and interest home loans.

P&I Loan Element How can you optimise your P&I Home Loan deal
Type of lender
The lender you choose to go with for your home loan could dictate your repayment experience considerably, so you should always consider the different examples on the market carefully. These are likely to form the bulk of your lending options: • Banks: you might find that with banks, particularly bigger ones, the loans and services offered cover a wider range than anywhere else, but rates, fees and conditions aren’t the best on the market. • Credit unions: these operate very similarly to banks, but the nature of their ownership (by its members) allows it to plunge profits back into the credit union to help members save on interest and other costs. • Online or non-bank lenders: these lenders are generally smaller than banks and credit unions but are more likely to offer a cheaper, specialised service to you. They’re not regulated in the same way, though, and many aren’t accredited to receive deposits.
Interest rates
Interest rates are easy to compare, with their big, bold numbering on any lender website or advertisement. What you should always keep in mind is that a seemingly insignificant interest rate difference can amount to hundreds or thousands of dollars in the long run. For example, a $500,000 loan paid over 30 years with a 3% rate could end up costing you just under $760,000, but a rate of 2.8% could save you almost $20,000.
Comparison rates
Despite what you might think, this is the true number to look out for. A loan’s comparison rate indicates how much you’ll be paying on top of your principal not only in interest, but also fees. Lenders won’t advertise their fees, but are legally required to display a comparison rate when advertising their loans. Look out for lower comparison rates as much or even more than interest rates, as you can save yourself hundreds in one-off fees with the right loan.
Monthly repayments
Interest and fees will largely inform how much you’ll pay from month to month, but you can’t afford to just look at the big picture. How much you’ll be able to pay back per instalment could not only shape your choice of loan and lender, but likely your budget for a new property.
Added features
Lenders will often sweeten their loan deal by throwing in bonus features that can improve your repayment experience. These may include: • Offset account: having one of these with your P&I loan can make a huge difference. With these, you’ll be able to deposit funds into an account connected to your mortgage to reduce your principal without having to pay interest. • Additional payments: some loans may charge you a fee to make additional payments, but if you’re able to do it for free, you can cut down your principal much more quickly. • Redraw facilities: this feature will grant you access to any additional repayments you’ve made and allow you to withdraw from them however and whenever you wish. It adds flexibility and coverage if you encounter an unexpected bill.

What is an interest only home loan?

Interest only home loans are the main alternative to principal and interest loans, whereby the borrower spends the first part of their loan (usually 1-5 years) paying off solely interest and then the rest paying off both principal and interest. This method of repayment is advantageous for those who don’t have quite as much up-front, allowing their payments to be back-loaded to free up extra funds.

Interest only home loans are also amongst the most popular choices for property investors looking to add to their portfolio. The lowered repayments for the first part of their home loan can enable them to free up some much-needed funds if they’re still paying off other debts. Also, it can open the door for investors to claim more in tax deductions from their investment property. However, it is important to note that this type of loan will cost you a fair bit more in interest over the life of your home loan. In addition, while it may feel like you’re making inroads on your home loan, you’re not actually making a dent in the principal during your interest-only period.

Principal and Interest vs Interest Only

This is a comparison of a principal and interest loan against an interest only loan, to show how much you might be able to save.

You take out a home loan of $300,000 with a loan term of 30 years and an interest rate of 3.85%.

 

Principal and Interest

You elect to pay your loan back with principal and interest payments.

In this case, you’ll be paying your lender $1,407 each month for the duration of your home loan. Over the course of your loan, your repayments will total $506,313, which includes interest of $206,313.

Interest Only

If you choose an interest only loan with the interest period of 5 years, the story is a little different.

During the interest only period, your monthly repayments will be $1,085 per month. However, once the interest period ends and you begin to pay both principal and interest, you will be paying $1,559 per month, a sizeable increase. That means that over the course of your loan, you’ll pay a total of $532,731, which includes $232,731 worth of interest.

Conclusion

These sums paint a clear picture of the benefits and downsides of each principal and interest, and interest only loans.

In the comparison above, if you elect to pay off both principal and interest from the very start of your loan, you’ll save at least $26,418 over the life of your home loan.

Common queries about principal and interest loans

If you haven’t had your burning principal and interest loan question answered, here are some of the most frequent.

Can I use a principal and interest home loan to buy investment property?

Yes – most types of investment home loan are structured around principal and interest repayments. These are useful for investors looking to keep their property long-term. Investors may elect to go with an interest only period on their home loan if they plan on selling the property, as they pay less during their period of ownership.

Are principal and interest loans good for first home buyers?

Yes – first home buyers who are in a financial position to do so should consider a principal and interest loan. However, as many are young people who might not have reached the peak of their earning potential, interest only loans are quite popular. This is due to the lower repayments for the interest only period, which might allow them to save while consolidating other finances. If you’re a first home buyer and can afford repayments on a principal and interest loan, you will be saving a significant amount on interest over the term of your home loan.

Will my credit score affect my principal and interest loan application?

Yes – your credit score and history will be carefully analysed by lenders to determine whether you’re a suitable candidate to be approved for a home loan. If your score isn’t quite up to par, it could kill your application. You can improve your credit score by paying off any debts regularly and on time, as well as lowering the limits on any credit cards to prevent overspending.

Can I be approved for a principal and interest home loan if I’m buying an apartment or rural property?

Yes – although approval for these loans can be harder than a standard property in a metropolitan area, they’re available to those who are looking for them. Lenders tend to see them as higher risk, so you should always ask your lender in advance how they manage these sorts of loans.

Should I get pre-approval for my principal and interest home loan?

Yes – pre-approval is a conditional, non-binding estimate that a borrower will receive from a lender to give an indication of their borrowing capacity. It’s not compulsory to get pre-approval, but it can help you gain an understanding of what you can afford at open inspections and open you up to making an offer on the spot.

Can I be approved for my principal and interest home loan if I’m a casual employee?

Yes – if you’re borrowing within your means, have a decent credit and financial history and have been in the job for an extended period of time, there are lenders who’ll accept your application even if you’re a casual worker.

Should I save for a large principal and interest home loan deposit?

If you can, absolutely – the greater your deposit, the more you’ll save on interest and fees in the long term. It’ll also increase your chances of home loan approval significantly if your lender doesn’t have to put up as much of their own money.

How do I work out what I’ll be repaying on my principal and interest home loan?

Find out more about how your home loan repayments will be calculated by reading our guide on how to calculate home loan interest rates.