There are a few ways your mortgage can be set up to best suit your financial goals
and your cash flow. Interest-only (IO) home loans are often the loan of choice by
investors as they allow borrowers to pay only the interest on their borrowed amount
for a period of three to five years, reducing the monthly repayments for that period.
However, as with any type of mortgage, there are advantages and disadvantages, so
it’s important to understand what’s best for your circumstance before deciding
whether an interest-only loan is the right option for you.
Cash flow benefits of interest-only loans
The upside of interest-only loans is that they lower repayments during the interest-
only period, which can help borrowers manage their cash flow and plan better for
unexpected expenses or invest in renovations or other projects. “This type of loan
can also be useful for borrowers who expect their income to increase in the future,
as they can afford to make higher repayments later,” says Jaime Pratt, Head of PM
at VPM.
Hidden risks of interest-only loans
While IO loans seem like a good deal initially, they do come with downsides.
According to Jaime, one of the biggest risks is that when the interest-only period
ends, the borrower will have to start repaying the principal as well. “Your repayments
can increase significantly,” she warns. “If you haven’t prepared yourself for the
increased repayments, it can potentially be a particularly difficult time financially.”
Another thing to keep in mind is that IO loans can extend the overall mortgage term,
as borrowers will have to pay off the principal over a longer period of time.
“Furthermore, the interest rates for IO loans can typically be higher compared to
principal and interest loans."
Preparing for the end of your interest-only loan
Before taking out an IO loan, you should carefully consider what your full repayment
commitment will be once the loan expires. “This will help you to adequately prepare
for the higher repayments that will be required,” Jaime advises. “It’s also important to
note that interest rates may rise over time, resulting in higher repayments than
anticipated.” To prepare for this, you may want to consider making higher
repayments ahead of time or refinancing your loan altogether.
Key points for investors
There’s no doubt that IO loans can be a good option for certain buyers, particularly
investors. However, caution should be taken not to purchase a property that is
beyond your financial means. “Just remember that IO loans will eventually become
P&I loans. To avoid any surprises, it’s so important to carefully read and understand
all loan documents before signing them.”
If you’re considering the most suitable loan for your next investment property,
contact our team, who can personally connect you with a financial provider in our
professional network.
* Please note: This information is not intended to replace legal and financial advice.
Please consult your financial advisor and legal team for information relating to your
individual circumstances.
