Interest Only Loans: What You Need To Know

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Interest Only Loans: What You Need To Know

There’s been some media buzz about interest only loans, read this to find out what they are and how an interest only loan might impact your budget.

Recently there has been some media buzz about interest only loans.

These types of loans have received increased scrutiny due to the royal commission into the banking sector, and potential impacts on borrowers who haven't properly prepared.

In today's blog post we're going to talk a little about interest only loans, what they are, and what to do if you have one.

 

Interest Only Loans - What Are They?

Most loans require the borrower to pay back both the principle (the original amount) and a certain amount of interest on that loan.

In this way the borrower slowly chips away at the debt owed while the lender makes a little bit of money out of the loan.

With an interest only loan the borrower only pays back the interest on the loan for a set period of time, so the repayments are lower at the beginning of the repayment period.

However since the principal isn't being paid, the base amount of the loan doesn't change.

 

More Expensive In The Long Run

In the long run this makes these types of loans more expensive as only the interest on the loan is being paid. 

As the amount of money owed doesn't decrease over the interest only period you'll end up paying more interest over the life of the loan.

Ultimately you pay more money to save a little in the early stages of the loan.

 

Benefits

That said there are some benefits to an interest only loan.

To begin with your loan repayments may initially be substantially lower when compared with a standard loan.

If you're an investor you may be able to use the loan to maximize your tax deductions.

 

So what has everyone worried?

As we've previously explained an interest only loan means you only pay down the interest in the early stages of your loan. Eventually however you will have to begin paying the principal and the interest.

This can lead to what some call "payment shock". As the loan switches over to the interest & principal your repayments can jump suddenly and sharply, and some borrowers may find that those new repayments strain or break their budgets.

Whether it is because borrowers haven't prepared well enough, or the property hasn't appreciated in value as expected, this can leave some borrowers extremely vulnerable.

This is what has worried the RBA and some experts: many interest only loans are beginning to make this transition.

And with this transition some borrowers are finding they have to repay more than they expected, or can afford. Leaving them in a state where they can no longer make their mortgage repayments.

 

What to do if you have an interest only loan?

If you have an interest only loan which is about to make the transition there are a few things you can do to prepare for it.

  1. Re-do your budget
    If you haven't looked at your budget for a while it might be time to have a look at your income and expenses. Make sure you factor in the increased loan repayments and look for where you can be more disciplined.

  2. Negotiate a better deal
    If you're on good terms with your lender you may be able to negotiate a better deal. There is plenty of information out there on how you can negotiate lower repayments with your lender. Ultimately they want you to make repayments, so most places will be reasonable.

  3. Refinance
    If you can't negotiate better terms then you may want to look at refinancing your loan.

 

Take action today.

Regardless of what you do, it is better to take action now then wait until you're already under pressure. An interest only loan can be immensely helpful, however it does have some risks that other standard loans don't carry.

If you're unsure about how you should finance your property investments, get in contact with us today and we'll go through our PPIA investment strategy with you and make sure you're investing with confidence.

The advice provided on this website is general advice only. It has been prepared without taking into account your objectives, financial situation or needs. Before acting on this advice you should consider the appropriateness of the advice, having regard to your own objectives, financial situation and needs.

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