Firstly, what is an interest only loan?
As the title indicates, an interest only loan lets you pay off the interest your loan has accumulated without paying back your principal loan (the money you borrowed). This means you’re making much smaller repayments but your actual loan doesn’t get smaller over time. At the end of your loan term, you’ll need to pay back the full amount owing in one final payment.
What is a principal and interest loan?
In the case of a principal and interest loan, your repayments cover the interest charged on the amount you borrowed, as well as a small portion of your principal loan. To begin with, your repayments will largely cover the interest your loan has accumulated, but over time the interest reduces as your loan becomes smaller.
Choosing between an interest only home loan and a principal and interest home loan will largely depend on your circumstances. It’s a good idea to talk to your accountant or mortgage adviser before deciding on this type of lending.
Advantages of an interest only loan
Interest only loans suit certain people at certain times in their lives. Here are the benefits of an interest only loan:
Buy a more expensive property than you could afford with a standard fixed rate mortgage. Lower monthly repayments – keep costs low. Potential tax benefit to investors. Frees up cash to invest elsewhere. Disadvantages of an interest only loan
There are a few negatives to this type of lending too. These include:
You still need to pay back your principal loan – could be a financial burden if you haven’t planned ahead. No equity – your property could lose value and you end up owing more than it’s worth. You could be tempted into spending more than you can afford. This type of lending could suit investors who plan to hold onto the property for a few years, rent it out and then sell it on. Investors may also benefit from tax deductions on interest only loans. But, if you’re an ordinary home owner looking to buy your family home and get mortgage free, an interest only loan is not your best option, long term.
Seek advice before deciding
There’s been a fair bit of media hype around interest only home loans recently, with many financial experts believing that this type of lending contributed to the property crash in the USA. Across the ditch, interest only loans are a popular option too, making up 39 per cent of all residential loans in Australia (September 2016 figures released by APRA).
While interest only loans are certainly on the rise here in New Zealand, this type of lending hasn’t reached those levels yet. It’s vital you seek expert financial advice before choosing an interest only loan. Get in touch with Best Mortgages to find out more.