Interest only rates can vary a lot between lenders depending on their current appetite and how much you’re looking to borrow.
Compared to home loan interest rates, it’s a moving target that’s hard to predict and, when you couple this with interest only rate loadings, it’s easy to be taken for a ride by the banks.
How much can you borrow?
- Interest only for homeowners: Borrow up to 80% of the property value (conditions apply).
- Interest only for property investors: Borrow up to 90% of the property value.
- Interest only rate: Depends on the strength of your application and the lender’s general appetite.
- Loan term: 5-10 years.
- Fixed and variable rates available: The fixed or variable rate term (whatever you choose) must match your interest only term.
Learn about the benefits of interest only loans and how not to get caught out.
Call us on 1300 889 743 or complete our free assessment form to speak with one of our mortgage brokers to find out if you qualify for a sharp interest only rate.
How much will I be charged?
Higher rates are applied to interest only loans because there is a higher inherent risk, namely, that you’re paying down the principle component of the home loan.
So instead of declining your application altogether, most lenders rate for risk and will typically charge 0.15% to 0.60% more than their Standard Variable Rate (SVB).
Some lenders have special interest rate offers from time to time where their interest only rate is comparable to their principle and interest (P&I) rate. Call us to find out!
Tips for getting a lower interest only rate
Select lenders who have a higher appetite for risk are willing to offer deals much closer to standard home loan rates. How to better your chances:
- Reduce your Loan to Value Ratio (LVR): Low rates are available when the amount you’re borrowing compared to the value of the property is less than 80%.
- Be in a strong financial position: This includes having a strong income, minimal debt and good savings.
- Have a clear credit file: Your credit file should be free of black marks like credit card and utility bill defaults and you should be making your repayments on time.
- Find a lender that uses actual repayments: Some lenders will assess you on the actual repayments you will make while others will assess you on 1.2 times repayments or higher which can have a significant impact on your borrower power.
While it’s difficult to “time the market” and apply for an interest only loan when rates are at the absolute trough, identifying this quickly and fixing your rate can help you avoid rate hikes in the future.
A mortgage broker can help you achieve this.
Beware of interest only rate loadings
One of the biggest costs overlooked is the impact of interest only rate loadings.
These loadings can be anywhere between 0.10 to 2.00 percentage points above what you would normally pay for an investment loan.
Investment loans themselves are already around 1.00 percentage points above standard home loan rates.
For example, if your investment loan rate is 4.10%, opting for a 5-year interest only term would see you potentially paying 5.10% per annum.
On a $500,000 home loan, you would be paying $2,125 per month in interest for the first 5 years compared to $1,708.33 per month for the first 5 years with no loading.
Some lenders are sharper than others when it comes to interest only rate loadings!
Call us on 1300 889 743 or fill in our online enquiry form to discover how much you could save by choosing the right lender.
Also, try out the interest rate calculator to give you an idea of whether interest only matches your financial goals.
Does the loading apply to homeowners?
What if you’re not buying an investment property and purchasing a home to live in instead?
An interest only loading will still apply and it will actually be the same as it is for an investment loan.
Can I avoid interest only rate loadings?
Not entirely but the gap does narrow when the property market is strong and the Australian Prudential Regulation Authority (APRA) has confidence in bank lending standards.
During times when regulators crack down on investment and interest only lending, we find that select second-tier lenders on our panel offer cheaper interest only loans and loadings compared to major banks.
You’ll not only save thousands but you’ll be able to borrow more because you won’t be subject to such large interest buffers that can limit your borrowing ability.
Why do banks load the rate?
There are many reasons that banks apply an interest only rate loading.
This includes their cost of funds, the profit they stand to generate from loan sizes and loan terms (many investors “flip houses” within 2-3 years) and default rates when interest only terms revert to principal and interest (P&I) repayments.
How much the bank loads will depend on the level of risk they’re willing to accept.
You’re borrowing power is reduced with interest only!
Lenders assess your loan over the remaining P&I term which means that a loan over 30 years with a 5-year interest only period will be assessed as a 25-year loan.
Effectively, your mortgage repayments will be higher over 25 years which may see the lender decline your application because, to the lender, you can’t afford the repayments.
Most lenders will apply this same logic to existing loans as well which can be a big problem for borrowers with existing investment loans!
On top of that, the lender will apply an assessment rate under the assumption that rates will rise.
This will generally be the actual rate plus 2-7.25%, whichever is higher.
You’re already being charged a higher interest rate for an interest only loan so the assessment rate and shorter term that it is assessed over could see your application declined.
The good news is that there is a lot of variation in how lenders assess your borrowing power.
Contact us and we can help to find the right solution.
Please note that we believe in responsible lending so will complete our own assessment of what you can afford.
When is it a good time to get an interest only loan?
When rates are high and you have a long-term plan in place to use the extra cash flow to fund future investments.
Is there ever a bad time to go with interest only?
When interest rates are relatively low, at least historically speaking, it’s a good time to pay down more on your principal component.
That way, you’re putting yourself in a better position should interest rates rise in the near future.
It also allows you to maximise the equity in your property, giving you a buffer in the event that your property decreases in value or should you plan to invest in property down the track.
Of course, this really only applies if you’re a homeowner.
If you’re an investor looking to quickly build a portfolio, getting an interest only loan is typically more beneficial to you in a low interest rate environment.
Is an interest only loan right for me?
Interest only loans are not suitable for homeowners who are simply trying to reduce their monthly repayments because they can’t afford P&I.
Your home loan will eventually revert back to much higher P&I repayments at the end of the IO term, whether it’s 2, 3 or 5 years.
This can be a surprise to homeowners who haven’t budgeted for this eventuality.
The other problem is that the interest bill that you pay on the principal amount will much be higher over the life of the mortgage than if you were to have made P&I repayments from the beginning.
Investors with a good plan in place benefit the most from interest only terms because they can use the extra cash flow to fund other investment opportunities.
- IO only can help you to maintain your cash flow during the renovation process when flipping houses.
- IO can give you a buffer to pay down non-tax deductible debts first before paying down the principle on your investment loan.
Then there are the tax benefits of pursuing an interest only investment strategy.
Alternatively, if you’re planning to hold onto the property over the long-term for rental income, a 3-5 year interest only term may not be good for your return on investment.
We can help you to make the right decision
Check out the interest only versus P&I page to learn more about the benefits and drawbacks of each repayment schedule.
P&I home loans come with much cheaper interest rates and it means we have much more negotiating power with the lenders.
Speak with one of our interest only and investment loan specialists on 1300 889 743 or by completing our free assessment form today.