Is an Interest Only Home Loan a Smart Move for You?

January 16, 2017

Is an Interest Only Home Loan a Smart Move for You?

Interest only loans started out as a smart strategy for property investors who needed an affordable way to make mortgage repayments on multiple properties. Why they work in this scenario is that investors are able to access the equity on their property while saving by only paying the interest for a set period of time usually five years or less. The bank still owns the property, but the borrower can benefit from being able to make smaller payments (interest only) at the beginning of the loan. Then, over time, the investors can raise the rent on their tenants so that when their mortgage repayments increase, they will have the rental income to cover the payments.

Today, some owner occupiers are opting for interest only to take advantage of the upfront savings. Are you considering going the interest only route? While there are advantages, there is some risk involved as well, especially right now in an economic climate of rising interest rates. Here is what you need to think about when you are in the market for an interest only loan or want to refinance to extend your interest only payments.

Will Your Income Increase?

While paying less during the interest only period may seem enticing, there is a real danger here of getting used to the smaller mortgage payments and then not being able to deal with the increase once you go into making principle and interest payments. Younger homebuyers who may expect a raise or a promotion within a few years may do well by starting out with interest only as they know they will have more money coming in to cover the larger repayments. If you expect your income level to remain the same, then you will have to be careful to make sure your budget is ready for higher repayments once the interest only period ends.

Are You Investing in Another Property?

If you are investing in a property that you are going to rent, then interest only payments can provide you a starting period with which to start earning a rental income on your property, without having to worry about principle and interest payments. You may also be able to refinance to extend this option.

Will Capital Gains Balance Out Your Principle Owed?

With interest only, you can save 15 percent a year on your mortgage. Even though you will not be reducing the principle owed on your loan, you may still benefit from an increase in your home’s value if you purchased a property in Sydney, Melbourne, or another of Australia’s hotter markets. This is something you want to keep in mind; if you don’t expect to benefit from capital growth, then saving early on with your repayments may not be a wise move.

What Are the Interest Rates Doing?

While the Reserve Bank of Australia has not yet issued a rate hike, many lenders have increased rates already. Forecasters are predicting that rates will continue to go up throughout 2017, especially if inflation increases in Australia or if the Federal Reserve in the United States raises rates again. This can make paying back your loan extremely difficult, especially if your interest only period is ending and you will have to make payments on both principle and interest.

You may be wise not to take on an interest only loan when you know that the rates are going to go up. It is also a good idea to avoid this type of lending product as a way to help you pay for a mortgage that you ca not comfortably afford.

Remember, when paying off your mortgage, the best way to save money is to focus on paying down your loan as quickly as possible. An interest only product should only be used as a short term option if it is right for your circumstances. With mortgage rates expected to go up, now may not be a great time to refinance to extend an interest only loan or to switch to this option if you will be in a good position to make your principle and interest payments in the future. If you are thinking of refinancing before rates go up more, consider talking to your lender about getting a better rate or shop around to find out if it is worth it to refinance with another lender.

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