What is an interest-only loan?

An interest-only loan is when your repayments are only the interest costs of the loan, compared to repayments being made up of both principal and interest. It is common for the interest-only loan period to be a set period of a loan term, for example, a 30-year loan term may be structured as 5 years interest-only and 25 years principal and interest. Each lender is different, and the terms of their loan will differ, to find out more speak to a broker.

My interest-only loan term is due to expire, can I extend it?

This is dependent upon the type of loan you have. Some are more flexible than others. If you initially secured your loan through a broker, ask them for the best options available to suit your needs. If you are dealing directly with the lender, call them and discuss your options.

Can I extend my interest-only periods at the end of the 5-years?

This will depend upon your current loan terms. Some lenders previously required applicants to go through a new application process to gain an extension of their interest-only period. Recently some lenders have relaxed their policies and depending on your current situation they can grant an extension without having to go through a new application process. Some lenders now allow a 10-year interest-only period on a 30-year loan.

I have spoken to my current lender and they would not give me another 5-year interest-only period. Do I have any other options?

One option might be to move to another lender that will suit your needs but remember you will have to go through the application process again, and there may be costs involved in moving from your current lender. To understand the process and potential costs you should speak to a broker.

What happens when the interest-only period of my 30-year loan expires?

If you do nothing, your loan will revert to principal and interest repayments – this will also mean your loan repayments will increase as you are now also paying off the balance of your loan.

What are the advantages or benefits of interest-only loans?

Interest-only home loans can provide some short-term benefits, including:

  • Lower repayments at the start of the loan – This may help you maximise the amount of money you can borrow or give you the opportunity to pay off other high-interest debt.
  • Management of short-term lending needs – These loans are useful for transitional borrowing needs, such as bridging or construction loans.

What are the disadvantages or risks of Interest Only Loans?

Interest-only home loans seem more affordable because initially, the repayments are lower than the repayments on principal and interest loans, but they have some drawbacks.

  •  Long-term debt – as you are not forced to reduce the principal interest outstanding through regular capital payments, you run the risk of having the debt longer.
  • Exposure to changed banking lending guidelines – as the term of interest-only loans is typically no more than 5 years, you run the risk that the banks may have changed bank lending guidelines which means you may no longer be able to refinance the debt and therefore you may be forced to refinance on different terms in the future.
  • Possible difference in interest rate – The actual interest rate charged by the bank for an Interest only facility may be higher than a principal and Interest loan.
  • Interest-only loans cost more – The amount of money you owe does not reduce during the interest-only period, which means you may pay a lot more interest over the life of the loan if you do not reduce the principal balance. For example, a $500,000 loan over 25 years, with an interest rate of 5%, would cost you an extra $40,062 in interest if it was interest-only for the first 5 years.
  • Repayments will increase at the end of the interest-only period – When the interest-only period ends you’ll need to start repaying the principal as well as the interest – and, with less time to pay it off, your repayments are likely to be a lot higher.
  • Interest rate increases: If your interest-only loan is a variable rate product your rate will be affected in the case of a rate rise as compared to a fixed-rate product 

Reduce your interest payment with an offset account

An offset account allows you to combine your savings with your mortgage account, reducing the amount of money owing on your mortgage, which reduces the amount of interest calculated on your home loan. Offset accounts are much more effective if you put money in and leave it there.
An offset account can reduce the amount of interest you pay on your home loan. You can use an offset account for savings or as an everyday transaction account.

Can I make extra repayments on an interest-only loan?

Typically, you can but this will depend on the terms of your interest-only loan product, speak to your broker about your requirements