Interest only home loans are traditionally beneficial to property investors looking to maximise their cash flow and give them a buffer to invest elsewhere or when building a home.
By only having to make interest repayments for a period of your loan term, you can reduce the size of your mortgage repayments significantly.
Unfortunately, the industry regulator has forced banks to slowdown on approving interest only home loans so is it still possible to make just interest payments?
Getting approved for an interest only loan
Qualifying for an interest only home loan will depend on the lender you choose, the percentage of the property value you borrow and the purpose of your loan.
Lenders can vary greatly in how they assess your borrowing power (serviceability) and in the interest rates they charge you:
- Interest only home loan: You can borrow up to 80% of the property value if you have a good reason for choosing interest only.
- Interest only investment loan: You can borrow up to 90% of your investment property value with interest only repayments.
- Interest only term: The maximum available in Australia is 10 years.
- Getting a low rate: Banks load the interest rate for interest only loans anywhere from 0.1% – 0.55%. You’ll also pay more in interest over the term.
- Extending an interest only period: Extending is often declined by a bank if you’ve already had an interest only period in which case you may need to refinance.
- Maximising your borrowing power: Banks use different methods to calculate your borrowing power if your new or existing loans are interest only.
Do you need an interest only home loan?
We can assess your situation and help find the home loan solution that meets your needs.
Please call us on 1300 889 743 or fill in our free assessment form to speak with one of our mortgage brokers.
Will I pay a higher interest rate?
The fact is that rates on interest only home loans are a moving target.
Regulations around investment loans can change at the drop of a hat meaning the appetite for interest only home loans can vary between lenders.
It’s totally “flavour of the week”.
We can help you choose a lender that won’t charge you a higher interest rate and fix your home loan to prevent the lender from changing their rate later.
It pays to shop around and we can help you do it.
Maximising your borrowing power
The way banks calculate your borrowing power for an interest only loan is actually really complicated.
If you apply for an interest only mortgage, banks tend to deduct the interest only period from the loan term when calculating your borrowing power.
In other words, a loan with a 30-year term and a 5-year interest only period will be assessed as a 25 year loan. This significantly reduces your borrowing power.
If you have existing loans on interest only, some lenders use the above method while others use the actual repayments plus a small buffer.
This small difference in methodology can mean a big difference in your borrowing power, especially for investors with multiple properties.
It’s important that you understand your financial limits and talk to us about what amount you can comfortably repay.
Good reasons for choosing interest only
If you’re an investor, the most legitamte reason for choosing interest only repayments is that you want to use your funds to pay off your home loan which isn’t tax deductible and so you pay the minimum on your investment loans.
This is because an investor will lose some of their negative gearing benefits if they pay off their loan early.
Most lenders don’t even ask for a reason as this is accepted as standard.
If you’re choosing interest only repayments on a home loan then it’s more complicated.
Some examples of reasons why a homeowner may choose to pay interest only are:
- Buying a home: Choosing a one year interest only period can be acceptable to help you focus on buying furniture and renovating your new home.
- Self employed: Choosing to pay the minimum can be acceptable where you intend to make additional payments when your cash flow allows it or where investing in your business has a higher return than the rate of interest that you’re
- Opportunity cost: Some people choose to pay the minimum even on their home as they intend to invest their money elsewhere. This is viewed with caution by the banks.
- Moving home: If you are switching your home to be an investment property or you are buying a 2nd home and will be selling your original home later on then it’s ok to choose interest only in the short term.
- Downsizing: Having a legitimate exit strategy such as paying out the loan from your superannuation or downsizing to a smaller property in retirement can be accepted in some situations.
- Short term lower income: If you’re on maternity leave, moving overseas or working part-time then you may choose interest only for a short period of time until you are back on your full income.
- Investing in shares: If you have a loan that is used for investment purposes but it is secured on your home then it is ok to choose interest only repayments.
- Other reasons are assessed on a case by case basis.
What’s important is that you can afford the P&I repayments at the end of the interest only term.
If a bank is concerned about this then they will not allow an interest only period.
Not sure if you qualify for an interest only home loan?
Call us on 1300 889 743 or complete our free online assessment form to find out.
Can I extend the interest only period?
The interest only period normally lasts for 5 years. This means that you’ll only need to pay the interest portion of the repayments until the term ends.
Most lenders will allow you to extend the interest only term by another 5 years depending on how regular you are with your payments. A handful of lenders may even consider extending the period by 10 years.
We can help you refinance with a lender that can offer you a second or third 5-year period as long as this does not put you at a financial disadvantage and you have a good reason for choosing interest only repayments.
For investment loans in particular, refinancing is the best way to keep your repayments to a minimum.
What are the drawbacks of interest only?
The biggest drawback by far is the cost!
Paying P&I will not just help you qualify for a lower interest rate but, since you’re paying off the mortgage earlier in the term, you end up paying less in interest.
For example a $500,000 loan with an interest rate of 4.00% p.a. over 30 years will cost $32,408 more in interest if you choose to pay interest only for the first 5 years.
You should keep the following in mind:
- You’re not actually paying off the loan: Although the size of your repayments will be smaller, you’re only paying off the interest portion on the loan. You may have a tough time once the interest only period ends and you have to start making large principal and interest payments.
- You’ll need to refinance: Interest only periods last for a short while, usually 5 years. You may have to refinance to another lender if you wish to continue making this method of payment.
- You’re not building equity: These loans can be a much riskier than P&I loans as you won’t be building equity in the property. This means that if the value of the property decreases, you may end up with negative equity. Rise in interest rates can mean higher payments for the same value property.
- Your loan will revert back to higher P&I repayments: This in itself shouldn’t be a surprise but it can sometimes catch homeowners and even investors by suprise when you suddenly have to start forking out more for your mortgage repayments.
How often do I need to make the repayments?
Normally, banks don’t allow weekly and fortnightly payments if you’re making interest only payments.
This is because weekly and fortnightly interest only payments are usually considerably small.
Generally, you’ll be required to make standard monthly payments.
Am I allowed to make extra repayments?
Yes, banks usually allow you to make additional repayment on your loan.
Making higher repayments can help you reduce the size of your loan much faster. It’s also an effective way to minimise the loan term and reduce the interest that you’ll pay.
However, it’s important to keep in mind that you can’t make extra repayments if you’re on a fixed term or, at the very least, your ability to do so is restricted.
The only caveat to this is the fact that interest only periods and fixed terms are independent of each other.
With some lenders, it’s actually possible to get a 3-year only period on a 3-year fixed term.
The benefit of this is at the end of the 3-year fixed term, you can refinance to a lower interest rate and sign up for another interest only term (conditions apply).
How can an offset account help me?
Getting an offset account is a great strategy from a tax perspective. A loan with an offset includes the standard loan account linked with an offset account.
An offset account is a special account linked to the loan where you can make additional repayments to your loan account. It earns no interest, however, the bank will take the balance into account when assessing your loan interest.
This means that if you have a $800,000 loan and you’ve put $300,000 in the offset account, the bank will calculate interest on just $500,000. This can make a huge difference on the tax amount.
To learn more about offset accounts, you can speak with one of our mortgage brokers on 1300 889 743 or complete our free online assessment form.
Why are banks limiting interest only approvals?
The Australian Prudential Regulation Authority (APRA) asked the banks to reduce the number of interest-only home loans they were approving in a move to reduce system-wise risk.
This was in response to the likelihood of a slowdown in housing price growth and the affect it would have on highly-leveraged homeowners.
The industry regulatory believed too many homeowners were choosing interest only home loans without being fully aware of the increased cost of these loans.
Interest-only owner-occupier loans make up around 40% of all interest-only loan approvals.
As a result, APRA forced banks to limit interest only approval to just 30% of all residential lending.
Despite this, it’s still possible to qualify for an interest only loan so speak with one of our experienced mortgage brokers about your situation.
Call us 1300 889 743 or complete our free online assessment form today.