Interest only loans

An Interest Only Loan refers to a loan when the borrower is only required to make only the interest repayments based on the principal balance of the loan for a specific duration, typically between 1 to 5 years. During this period, as the borrower is not required to make the principal repayments, the loan balance will remain the same.

How does it work?

The borrower will select how long they want the loan to be on Interest Only payments, generally between 1 to 5 years. So, if you choose a 30 year loan term with an interest only period of 5 years, this means that for the first 5 years your loan repayments will just be the Interest based on the principal balance and then once the interest only period expires, the remaining 25 years will be based on Principal and Interest (P&I) repayments.

What are the benefits of an Interest Only Loan?

  • Lower repayments: As the repayments are based on Interest only, this will result in a lower monthly payment compared to paying down the principal and interest.

  • Cashflow management: Interest only loans offer flexibility for borrowers to allocate more of their funds to focus paying down their non-deductible debts, higher interest debts or for further investment opportunities.

  • Tax benefits: Interest paid on loans may be tax deductible. We recommend that you speak to a tax agent to get advice on the tax benefits and implications. If you have an Investment home loan on an Interest Only option, you may be able to maximise the negative gearing benefits compared to if you make P&I repayments which will reduce the negative gearing over time as your balance reduces.

Things to beware when considering an interest only loan

  • There’s a set number of years your loan can be interest only, depending on your serviceability, this may be between 1 to 10 years. It’s important to understand what will happen to your loan at the end of your interest only period.

  • When your interest only period has expired, your loan will automatically become Principal and Interest in repayment. The minimum repayment amount will be calculated based on the remaining term of your loan, which can mean a massive jump in your minimum repayments.

  • Before considering an interest only loan, you should always have a plan or exist strategy on what to do when the interest only period expires. If you meet the bank’s lending criteria, you may be able to refinance this loan for another 30 years and restart your interest only period, or you need to understand what the potential Principal and Interest repayment will be to ensure you have enough cashflow to support the higher loan repayments