Interest Only vs Principal and Interest Home Loans
When it comes to choosing the right loan for you, a good place to start is deciding between an Interest only vs Principal and Interest home loan. But what exactly are they and what’s the difference? Let’s take a look.
What is a Principal and Interest Home Loan?{yellow-border}
What is an Interest Only Home Loan?{yellow-border}
An Interest Only home loan means you only repay the monthly interest on the amount borrowed for a set term of one to five years. No repayments are required to reduce the principal amount borrowed, which means the loan balance doesn't reduce.
At the end of the Interest Only period, the loan will change to a 'Principal and Interest' loan and you'll start repaying the amount borrowed, as well as interest on that amount. Your loan repayments will be higher for the remainder of the loan term than they would have been if you had made Principal and Interest repayments from the beginning of the loan, because you will have less time left in the loan term to pay off the principal amount.
How long can I be on an Interest Only term?
Who might consider an Interest Only home loan?
Interest Only home loans are a popular choice for property investors. Instead of repaying the principal amount of the loan from the start, investors can use this money to make improvements to the property, with a view to making the home more appealing to renters and increasing rental income.
Important: Interest Only loans are not right for everyone. To understand whether an Interest Only loan might suit your circumstances please contact us, speak to your Broker or discuss with your financial adviser.
Interest Only vs Principal and Interest Home Loans{yellow-border}
It all comes down to what your repayments are used for and the effect that has on your ongoing repayments.
While your repayments during an initial Interest Only period will be lower (given no principal balance is being repaid), after the initial Interest Only period ends, the loan will convert to Principal and Interest repayments. You will now have a shorter time period left to pay off the principal. As a result, your repayments are likely to be higher over the remaining term of the loan.
An Example{yellow-border}
To get a clear picture of what a Principal and Interest vs Interest Only home loan can mean in real terms, let’s put some figures to it.
Principal and Interest Home Loan
Tom has a $450,000 owner occupier loan and wants to pay down his loan balance so he can build up some equity.
Tom pays monthly Principal and Interest repayments of $1,897.
Over the next three years, Tom:
- Pays a total of $68,000 in loan repayments; and
- Reduces the principal balance of his loan by $30,000, down to $420,000.
Interest Only Home Loan
Anna has a $450,000 investor loan and only wants to make interest repayments.
Anna pays only the monthly interest of $1,146.
Over the next three years Anna:
- Pays a total of $41,300 in Interest Only loan repayments; and
- Does not reduce the principal balance of the loan - it has stayed at $450,000.
Pros and Cons{yellow-border}
Principal and Interest Home Loan
- Usually offered at a lower interest rate than an Interest Only home loan
- You’ll pay less interest over the life of your loan (because you’re reducing the principal on which the interest is charged) and that means you’ll pay off your loan sooner
- Higher monthly repayments - owner occupiers/investors may want to utilise the funds differently
Interest Only Home Loan
- Initially your repayments will be less than if you were also repaying the principal
- May suit your tax arrangements and financial strategy if you’re an investor
- While repayments could be smaller during the initial Interest Only term, they could increase after the Interest Only term ends and you could end up paying more in interest over the life of the loan
Buying An Investment Property
Here's some tips and advice on what you should consider when looking at investor home loans.
Interest Only Home Loans
An interest only home loan requires you to only repay the monthly interest on the amount borrowed (the principal) for a set term of 1-5 years.
Manage Your Home Loan
Find out how to get the most out of your home loan at BOQ.
Need more information?{yellow-border}
We’re here to answer any questions you may have.
Chat to us
- Call us on 1300 55 72 72
- Locate your nearest branch
- Speak to your Broker about your BOQ home loan
