Is taking out a home loan with no interest your best option?
Benefits of Only Paying Interest
It’s clear why interest-only loans are appealing. You will have more money to do other things during the period of time – usually five years – that you are not paying down the principal (the actual amount of your loan).
With a new home loan, paying only the interest means you have more cash available for other things. If you’re setting up a first home, this can be very useful. Buying furniture and whitegoods isn’t cheap. It can also help you establish an early savings buffer.
At the end of the five years the loan will return to principal and interest (P&I). If everything goes according to plan, you could be earning a little bit more. After that, it should be simpler to afford the extra loan repayments.
Sounds fantastic. And that’s why interest-only loans remain popular for those taking out new home loans. So why wouldn’t everyone do it?
The Interest Rate Equation
For the decade or so leading up to 2022, Australian borrowers enjoyed record low interest rates. With less payable in interest, many home-loan holders added extra payments to their mortgages. This was an excellent strategy. At that time, the idea of an interest-only loan didn’t make much sense. It was better to pay down the principal, reducing interest as you went.
In the 4 years from 2017, the proportion of interest-only loans in Australia dropped from 40% to 30%.
But when interest rates are higher, it can make sense for new borrowers to take out interest-only loans, or for those already with loans to switch to interest only for a period of time.
Having a five-year interest-free term on your loan has a cost in the long run. For instance, if you begin with five years of interest-only payments on a $500,000 loan for 25 years at 4.5% percent, you will end up paying about $38,000 in additional interest over the course of the loan.
That’s a hefty price to pay for a quick upfront saving.
It’s also worth knowing that an interest-only loan is just that: you are not permitted to make payments on your loan principal. So if you get a pay rise, receive an inheritance or want to bank that tax return, you’re stuck. You can’t use that money to pay down the loan principal.
Even with higher rates, understanding the benefits of scratching away at the principal is important. It’s a question of more money now versus lower repayments later, and everyone’s circumstances will be different.
Ask Our Industry Experts
Get in touch with Mortgage Broker Group if you are looking for a new home loan, or thinking of switching to an interest-only loan. We’ll help you understand how switching will impact your repayments, both now and in the future.
Our advice comes at no cost to you, ever. Of course, your home loan lender will charge their usual fees if you do take out a loan.