How interest only home loans work

Last updated on November 25th, 2021 at 09:45 am by Bill Tsouvalas

Interest only home loans are becoming more and more popular in Australia with everyday borrowers.

Higher house prices and the rise in living costs force people to look for relief wherever possible, and putting your home loan on interest only is one of them. In general, this might be a good idea, but it’s not the best choice for those who take a mortgage too big for their bank balance or who are doing this just to pay bills.

What is an interest only home loan?

As you already figured out, with this type of loan, you pay just the interest on the loan. This means cheaper monthly repayment however you are not paying down any principle. 

In the past, this type of loan was used especially by investment property buyers mainly for the purpose of reducing the holding cost of a property until it was time to sell, usually with the aim to make a profit. Today an interest only option is usually offered to anyone with a home loan. 

Before making up your mind and running to the bank, let’s see the advantages and disadvantages of this option 

Advantages of interest only home loans

The main advantage, which has convinced many into choosing this kind of loan, is that it helps you free money for other things. Interest only loans have many benefits especially in the short-term. For the financially savvy ones, this credit gives them the option to take the extra money from the reduced mortgage payments and invest it into something that has a high return.

interest only is also a good option when you want to renovate or build your home. For example, if you plan on renting while you are building your house, you can arrange an interest only loan for one year. This way, it will be easier to meet the home loan and rental obligations.

Interest only could also work for you if you have a job in sales or agriculture, where income might fluctuate from month to month. Although an interest only option helps access money in the short term, it should not be used as an effective emergency measure for paying bills or buying groceries. If that’s the case, you need to seriously look at your budget and make some changes quickly. 

Disadvantages of interest only home loans

Interest only does come with some inconveniences. The biggest drawback is that you are not paying any money off your house, and you are not building equity either. This means that you are unable to borrow against it if the value of the property does not increase substantially. 

Compared to standard fixed rate loans, interest rates tend to be a little higher.

Do not go for this type of loan if you are looking for a long-term option. Interest only operates on a maximum of five years, so using it for a 25-year mortgage will be out of the question.

Before opting for this option, make sure you understand all that it implies. Talk to a specialist, ask all the questions you have and see if this type of loan is the best for you.

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