Interest Only Mortgages – How They Work
Interest only mortgages can be an interesting concept to those home buyers who have a traditional view of their mortgage as something paid each month so they eventually own their own home. An interest only mortgage is when a home buyer has bought a property and is having its purchase financed through a lender but has agreed to only pay the interest, not anything off the capital amount that was originally financed.
| Home Loan | Details | Interest Rate (p.a.) | Comp Rate^ (p.a.) | App Fee / Ongoing Fee | Max LVR | Min & Max Borrowing | |
|---|---|---|---|---|---|---|---|
 State Custodians Mortgage Company Breathe Easy Offset Loan |
Interest only repayments can make your household budget stretch further. | 6.27% | 6.18% | $0 / $0 | 95% | $150,000 / $1,000,000 |
 
|
 HomeStar Advantage Loan |
Make it easier at tax time by only paying the interest on your investment loan. | 6.28% | 6.28% | $0 / $0 | 95% | $150,000 / $2,000,000 |
|
HomeStar No Fee 100% Offset |
If you are taking out an investment loan choose the one with the longest interest only repayment period | 6.26% | 6.26% | $0 / $0 | 90% | $250,000 / $750,000 |
|
State Custodians Mortgage Company Standard Variable Offset Loan |
Interest only repayments are welcomed by lenders in the strong Australian property market. | 6.02% | 6.23% | $0 / $345 | 95% | $150,000 / $1,000,000 |
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Uses for an Interest Only Loan
You can often arrange to make interest only repayments for up to 10 years, never paying anything off of the principal, and instead just covering the costs of borrowing the money for your purchase. In order for the loan to be cleared the home buyer would have to sell the property, or come up with the capital owing in some other way. If you were to start repaying your loan on an interest and principal repayment basis after a period of interest only repayments, it could become quite hard to have the home paid for during the original loan term.
A short term interest only mortgage can be of great benefit to both the lender and the home buyer especially in the following cases:
- For a property investor. If as a property investor you plan to carry out value adding renovations and then resell the property for a profit before the end of any interest only period, then any money that would otherwise have gone towards paying off the principal will have been released to assist in the renovation work and the sale price of the newly renovated home will be much more than what is owing on the original loan.
- For a first home buyer. First home buyers can benefit from the lower repayments during the interest only period while on a lower wage when starting a career or business. As they became more settled they could then revert to repaying both interest and principal without losing too much as the increase in the property price would have been compensated sufficiently.
- When the interest only period is offered at a very low interest rate. This could be in the case of an introductory loan for example, and while the interest rate is low it is a good time to repay above the minimum repayments by making additional repayments. This will lower the principal owing and shorten your loan term and save you money in the long run because there is less principle to attract compounding interest.
Availability of Interest Only Loans
Interest only mortgage loans were more readily available before the Global Financial Crisis (GFC) when the economy and the property market were stable and booming, and lenders were secure in the knowledge that they would be able to cover the untouched principle amount if they had to sell a property in default.
When the economy recovered in Australia after the GFC and interest rates started rising again, interest only loans were highly sought after because many borrowers found it difficult to keep up with their interest and principal repayments. Interest only loans were the way many home buyers combated the effects of over extending themselves financially while interest rates were at historically low levels.
Approving higher and higher loan amounts for more and more Australians was good business for the banks while house prices kept increasing, as after two or three years the value of the home would exceed that of the amount borrowed. In more recent times however, house prices have either steadied in most areas, or fallen in others and so interest only loans are becoming much harder to come by.
With the GFC reminding all of us about the dangers of over extending ourselves financially, it is not surprising that interest only loans are no longer a favourite of the banks. There is the danger with an interest only mortgage that the borrower might be tempted to buy a home that is financially beyond them, and can only afford the repayments as interest only repayments, and are unable to ever repay the principle loan amount. Many borrowers reason that after an initial period their household income would have grown sufficiently to be able to afford the extra repayments, but nobody can see into the future. Illness may have struck, there may have been a business downturn, unemployment may have hit or you could have missed out on the promotion you were expecting. A lot of financial damage can occur if the principle loan amount can never be paid off, because you will never own your home.
Who is Suited to Interest Only Loans?
Interest only mortgages are best considered in times when house prices are increasing solidly and the equity you have in the home is growing naturally. You will be able to generate a similar situation if you can buy the house cheap and go about renovations that will increase its market value.
In any other situation such borrowing should only be entered into after much consideration of what the future holds. If you were to be stuck with an interest only mortgage that you could not get out of in times of falling house prices you could be in a situation where you can never own your home. While your lender might not be overly worried if you keep up the repayments, at the end of a 25 year loan term you will have paid out more in interest than the cost of the house in the beginning. You would have probably been no worse off financially if you had rented during that period.
The one saving grace in Australia is that house prices historically never remain depressed for a very long period; therefore you only need to ride out the bad times for a short time before you become more optimistic once again. If you think you are suited to an interest only loan, compare your loan options with Home Loan Finder.
Related posts:
- eChoice Interest Only Home Loans
- Fixed Rate Interest Only Mortgage
- Interest Only Mortgage Calculator
- Interest Only Investment Loan
- Honeymoon Mortgages as Introductory Home Loans
- Interest Management Loans
- Homeside Fixed Rate (Interest Only Mortgage)
- Discount Mortgages – Can You Get One?
- NAB Tailored Home Loan – Fixed Rate (Interest Only paid in arrears)
- How To Save Money On Home Loan Interest Payments
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