Is it in your interest?
As the name suggests, with an interest-only mortgage your
repayments only cover the interest on the amount you have borrowed,
during the interest-only period.
You might consider this type of loan if you're buying a house or
refinancing your mortgage, but you need to think carefully about
whether it will be the best loan for you in the long run. Here we
explain the risks and benefits of interest-only mortgages.
How do interest-only loans
Most home loans are principal-and-interest loans, which means
that your regular payments will reduce the principal (amount
borrowed) as well as paying off the interest.
With an interest-only loan, you only pay interest on the amount
you have borrowed for an agreed period (usually up to 5 years). At
the end of this time, the loan reverts to a principal and interest
loan and you start repaying the principal as well as the interest.
Before you take out an interest-only home loan, you'll need to work
out if you can afford the increased repayments.
Work out your repayments before and after the interest-only
Australia's interest-only mortgages
Take a look at our interest-only mortgages
infographic which explains how interest-only mortgages have
grown in Australia, how much people are borrowing for an
interest-only loan and how much you will really pay for this type
Using an offset account on an interest-only loan
Some people make extra payments into an offset account to reduce the amount
of interest they pay on their home loan.
This is a good strategy with an interest-only loan but it will
only work if you can keep making these extra repayments without
making any withdrawals. If you're tempted to dip into your offset
account, then you might be better off with a principal and interest
Case study: Violet and James get an interest-only loan
Violet and James took out a $500,000 home loan over 25 years,
with an interest-only period of 5 years. They planned to
reduce the interest they paid on the loan by making
extra payments into an offset account.
After 2 years, they decided to go overseas for a few months and
started withdrawing money from the offset account to cover their
trip. When they returned from the trip they had a big credit card
bill to pay off so they no longer had enough money to make extra
payments into the offset account.
When the interest-only period ended, they only had 20 years to
repay the entire $500,000 principal, so their repayments were
suddenly a lot higher and they struggled to keep up with all their
Risks of interest-only home
Interest-only home loans seem more affordable because their
repayments are initially lower than principal and interest home
loans, but they will cost you much more in the long run.
The extra interest you'll pay on an interest-only loan
During the interest-only period, you do not reduce the amount of
money you owe, which means you'll end up paying a lot more interest
over the life of the loan, compared to a principal and interest
loan. For example, with a $500,000, 25-year loan, with an interest
rate of 5%, a person would pay $40,062 more in interest with an
interest-only loan compared to a comparable principal and interest
Increase in repayments after the interest-only period ends
Once the interest-only period ends you need to start repaying
both interest and the principal, and you'll have less time to do it
in. This means the repayments after the interest-only period will
be significantly larger
Case study: Daisy's interest-only loan repayments
Daisy wants to buy her dream
appartment and has been looking online at the different loans
available. She needs to borrow $500,000, the interest rate
advertised is 5% and she wants to repay the loan over 25 years.
Daisy is deciding whether a loan with an interest-only period of
5 years or a principal and interest loan would be best for her. She
was worried that she might not be able to meet loan repayments
after the interest-only period ends.
Daisy used ASIC's MoneySmart's interest-only mortgage
calculator to see what the repayments on an interest-only loan
would be compared to a principal and interest loan.
While the inital repayments on the interest-only loan were only
$2,083 per month, after the interest-only period ends they increase
Daisy didn't think that she would be able to afford the
increased monthly repayments, when the interest-only period ends.
She decided that a principal and interest mortgage, with constant
repayments of $2,923 would better suit her budget.
No equity in your home
If your property does not increase in value during the
interest-only period, you risk having no equity in your home at the end of
this period, despite making payments every month. Holding no equity
in your home puts you in a risky position if there is a downturn in
the market or your circumstances change and you have to sell the
Benefits of interest-only home loans
If you will make extra repayments during the interest-only
period, and you can cover the extra payments when the loan reverts
to principal and interest, an interest-only loan might work for
you. You can also use the money saved from lower repayments to
repay higher interest loans like credit cards and personal loans.
Some people choose interest-only loans to maximise their tax
benefits or the amount they can borrow when they buy an investment
property. Find out more about property investment.
If you're considering an interest-only
loan, think carefully about whether it's the right loan for
Last updated: 25 Jan 2017