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What is a principal & interest home loan?

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There are a number of strategies you can choose from to repay your home loan debt. The key components of loan repayments are the principal and the interest.

The principal is the loan amount you borrowed from your lender to purchase the property.

The interest is the cost of borrowing the principal. Factors like loan interest rates, loan term, and how you manage your repayments over the life of the loan will determine how much interest you pay in total. 

Principal and interest vs interest only

When applying for a home loan, you can choose how you want to repay your loan. Generally, there are two types to choose from. One is interest-only repayments and the other is principal and interest (P&I) repayments.

Advantage of principal and interest repayments

With a principal & interest loan, the repayment includes both some principal and some interest.

This is the most popular type of loan with Australian borrowers. The main benefit of this is that it steadily reduces the principal owing, which results in paying off your mortgage and owning the property. 

Since principal and interest repayments cover both the principal and interest, they reduce the interest you’ll pay over the course of your loan. This is because with every principal and interest repayment you make, your principal loan amount is reducing.

Compared to an interest-only loan where your repayment amount will increase after the interest-only period expires. This is because principal is not being repaid during the interest-only period, meaning interest continues to accrue against the full loan balance. You will also have a shorter time left of your loan term to pay back your principal, as some of your loan term will be spent only paying interest.

An additional benefit of principal and interest repayments is that your equity can also grow as you pay down the initial loan amount.

Home equity is the difference between the market value of a property and how much you owe. Therefore, the more the principal balance you repay, the more equity you'll have in your home. 

Benefits of interest-only loan repayments

An interest-only repayment is where you only pay back the interest amount for an agreed period of time, typically between one to five years.

The main benefit of this is that it keeps your repayments lower. The interest-only option is usually more beneficial to property investors because the interest can be tax-deductible on an investment loan.

Also, this reduces the amount you need to pay in monthly repayments so less is coming out of their own pocket.

However, interest-only loans can often have higher interest rates than other types of home loans. It's also important to budget properly for when your interest-only period ends and your repayments increase. 

Reduce the principal you owe with an offset sub-account

An offset sub-account is a popular home loan feature that can help reduce the amount of interest you pay on your loan.. An offset sub-account is just like an everyday transaction or savings account, only that the total savings kept in the account is "offset" against the loan principal.

An offset sub-account has a similar effect as making additional repayment, only borrowers are still able to access their savings at any time. 

Find out more about how an offset sub-account works

Looking for the right type of home loan?

Your chosen loan type can make a huge difference to your repayments. To understand how much difference, you can use our handy home loan calculator to compare loans and repayment types.

Keep in mind the right type of home loan will depend on your goals and individual financial situation and it's always best to seek independent financial advice. 

To find out more, talk to one of our lending specialists today or start our online application process for a low-interest home loan today! 

Apply now

About the article

As Australia's leading online lender, loans.com.au has been helping people into their dream homes and cars for more than 10 years. Our content is written and reviewed by experienced financial experts. The information we provide is general in nature and does not take into account your personal objectives or needs. If you'd like to chat to one of our lending specialists about a home or car loan, contact us on Live Chat or by calling 13 10 90.

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