In recent years, interest-only loans accounted for about 40% of Australia's mortgage market, before measures were introduced by APRA (the Australian Prudential Regulation Authority) to restrict the growth of these mortgages. These restrictions imposed a 30% limit on the number of home loans issued by banks that could be interest-only.
Source: Reserve Bank of Australia
In 2019, the Reserve Bank of Australia (RBA) warned that about two-thirds of Australia's interest-only loans (worth about $360 billion) were set to roll over to principal and interest repayments in the next three years, with those borrowers facing repayment increases as a result.
While this might seem a bit 'doom and gloom', the reality is interest-only loans can be both a good and not-so-good product for different people. This article will go through the pros and cons of interest-only home loans, and how you can refinance both to one and out of one.
Interest-only (IO) loans only require you to repay the interest component of your repayments, hence the name. The interest-only part typically lasts for up to five years.
Principal and interest loans (P&I) on the other hand - which are the more popular type of home loan - require the customer to repay both the interest and the initial principal (the amount borrowed). This means interest-only loans have much lower repayments during the interest-only period. Let's compare repayments on a 30-year, $450,000 home loan with a 3.03% interest rate:
So you can see how much lower IO loan repayments can be. Not only are the repayments cheaper, but they can be very effective for property investors: interest repayments are considered an investment expense and are therefore tax-deductible, according to the ATO. So if you're investing in property, IO loans mean you're reducing your tax bill and also paying very little on that home loan to start with. This makes IO loans very popular with property investors who like to buy a property, minimise their holding costs, and then sell it for a profit, using the proceeds to pay off the loan.
You can refinance from a principal and interest loan to an interest-only loan. To discuss switching from P&I to IO repayments, speak to one of our home loan specialists.
So what's the catch with interest-only loans? Well for one, they are more expensive in the long term, as we mentioned in the beginning. Once the interest-only period ends your P&I repayments will be higher than before, even with a low interest rate, as you haven't actually been paying off any of your loan so far. You've just been delaying paying it off, which means you now have less time to pay off the principal, and the repayments will increase as a result. For example, let's compare the same home loan above but compare the repayments over 30 years and then 25 years:
That second loan will be more expensive overall. Refinancing to a P&I loan also comes with the added benefits of potentially getting a lower interest rate and better mortgage features, as IO loans tend to have slightly higher interest rates.
Refinancing from an interest-only loan to a principal and interest loan works in much the same way refinancing in general does: simply contact one of our home loan specialists and ask to switch.
Click here to refinance to an interest-only home loan with loans.com.au.
Tags: interest-only loan | refinancing your investment property