The interest only loan is not for everyone, but it can be useful for property investors in the right circumstances. As the name implies, the borrower need only pay the interest on the loan and nothing off the principal for an initial term (typically between one and five years). The interest rate can be fixed or variable over this time.
Interest only mortgages offer one big advantage relative to standard home loan types: very low payments over this initial term of the loan. Interest only loans are best suited for short-term returns. They essentially defer the cost of a property until a later time, providing the borrower with an opportunity to grab a potential bargain without crushing repayments.
Most mortgages work by requiring you to pay back a little bit of the principal with every payment; not much at first and then much more as the years go by. Interest-only loans delay principal payments for the first few years, resulting in significantly lower initial payments.
Interest only loan aids cashflow
These loans are popular with property investors as they tend to maximise the tax benefits available to investors over the long-term while preserving their cashflow position.
By choosing an interest only loan, you would pay less over the initial interest-only term than with a standard-type loan: you could keep more cash on hand to renovate your property or simply to profit from the rental income of your investment.
But here’s the catch: you still owe the full principal at the end of the interest only term as you have not repaid any of the principal of the loan. You may also face a steep jump in payments when you begin paying back the principal.
These loans can be useful if:
- You are a disciplined, savvy investor who is financially prudent and doesn’t overextend on something you really cannot afford.
- Your current housing loan is not stretching you too thin financially.
- You do not mind a bit of risk.
In a rising market that provides some capital growth in the property, the interest only loan could be a strategy worth pursuing, for the right individual. As always, the deciding factors as to whether this product is best suited to you will depend on your unique set of circumstances. However, it is always good to know the options available to you.