Interest Only Home Loans Explained
Interest only home loans have been available to investors for many years, and now an increasing number of borrowers are utilising these loans for their own home.
An interest only loan is similar to any other home loan, however instead of having to repay the loan, you are only required to pay the interest on the loan.
Traditionally these types of loans were used by investors to maximise their cash-flow as well as their tax deductions, however for borrowers using the loans for their own home it is all about reducing the monthly payments.
How Do Interest Only Loans Work?
With a traditional home loan, each repayment will be made up of interest as well as principal. The repayment amount will be calculated in a way so that your loan balance reduces over time, and will be equal to zero at the end of your loan term.
Interest only loans on the other hand allow you to pay only the interest that has accrued on the loan during the month. By only paying the interest, your loan balance will remain the same and will not reduce like a normal home loan.
In most cases the interest only period for a home loan will be limited to five or ten years, after which time the loan will revert to a standard principal and interest loan which must be repaid.
Generally the bank or finance company will allow you to reapply for another interest only period, however you may have to meet certain criteria for this to be approved.
Interest Only Loans Benefits
For property investors, interest only loans allow you to reduce your monthly expenses, which can free up additional cash-flow to make additional property investments.
For example an investor may only be able to afford full repayments on two standard loans, but could afford interest only repayments on three loans.
Another benefit for property investors is the ability to maintain the maximum tax deduction.
Interest payments on investment properties are fully tax deductable, however any principal repayments are not tax deductible. By ensuring that the loan balances never reduce, you will always be able to claim the maximum tax deduction on your loans.
In theory a property investor could continue to rollover the interest free period at each renewal and never have to repay the debt. This rarely happens however, as the investor will need to sell the property at some stage, and the proceeds from the sale must go towards repaying the debt in full.
For borrowers who are taking out a mortgage for their own home, the main benefit comes through the reduced monthly payments.
There are no direct tax benefits to home owners, however if you know that the home will eventually be used as an investment property, then you may benefit from maintaining an interest only loan to maximise the taxation benefits when the property switches to an investment.
Is An Interest Only Home Loan Right For You?
For property investors, it is generally accepted that interest only loans are the way to go. For owner occupiers, the case is less straightforward.
Interest only can be a good option for owner occupiers at a time when you need to maximise your cash-flow, which may be when you have a new child or other new expense. Long term however it will generally be an owner occupier’s strategy to eventually repay the debt.