Home loan terms are typically 25-30 years, and for however long you pay interest-only, you’re not actually reducing your principal owing. For a borrower that doesn’t sell a property for profit quickly, this means that eventually when your interest-only period ends, your repayments will be significantly higher.
This is because you’ve effectively just shortened your home loan term without reducing your debt.
For example, let’s take a 30-year, $350,000 home loan at a rate of 3%. If you were making principal and interest repayments, your monthly repayments would sit at $1,476. If you were paying interest only over a 5-year period, your monthly repayments would be $875. This is a savings, albeit short-term, of $601 a month.
Principal and interest vs. interest only home loan repayments comparison
| Principle & Interest | Interest-only for 5 years |
---|
Monthly repayments during interest only period | $1,476 | $875 |
Monthly repayments after interest only period | $1,476 | $1,660 |
Total repayments made | $531,221 | $550,422 |
Additional interest paid due to the interest-only period | / | $19,201 |
Source: RateCity.com.au.
Note: Based on a hypothetical 30-year, $350,000 home loan at a rate of 3%. Figures used for example purposes only and do not factor in rate changes or fees.
While the interest-only period may offer some short-term savings, it often leads to higher payments afterward. In the example, at the end of the interest-only period, monthly repayments increase to $1,660, which is $184 more than the standard principal and interest repayments. Over a year, this amounts to an additional $2,208 in mortgage repayments – roughly equivalent to a yearly utilities bill or a family holiday.
Here are some key points about interest-only home loans:
- Owner-occupiers: For those living in the property they have purchased, the interest-only period typically ranges from one to five years.
- Investment properties: For investors, the interest-only period can be longer, often extending up to 10 years.
- After the interest-only period: Once the interest-only period ends, your loan will revert to principal and interest repayments. This means your monthly repayments will increase as you start paying down the principal amount borrowed in addition to the interest. It’s crucial to plan for this transition to ensure you can afford the higher repayments.
If you’re considering an interest-only home loan, it’s important to plan ahead and prepare for the increased repayments once you come off the interest-only period. Using an interest-only loan for a long duration may not be the best strategy for everyone, as your total debt is not reduced during this period. It is important to have a clear plan for transitioning to principal and interest repayments to ensure you’re eventually paying down the debt.