When comparing whether principal and interest vs interest only loans are right for you or not, it’s important to consider your own individual situation first.
Even on a normal day, it never hurts to ask about decreasing the amount of interest that you are paying on your home, car or personal loan – and you’re well within your rights to. In fact, a recent survey conducted by Domain showed that over 80% of home owners would swap banks in order to get a better deal – and yet only one third had ever refinanced a loan.
However, understanding how interest rates work is something that baffles many homeowners. When it comes to exploring their options, some might be too scared of ‘rocking the boat’, or simply couldn’t be bothered. However, taking the time to review how much interest you are paying can only work in your favour in the long term, as it might dictate how your repayments are structured too.
With interest rates now at a historic low around the world, it’s understandable why both first home buyers and seasoned investors are weighing up whether principal and interest vs interest only loans are the right choice for them or not. While the latter has often received a bad wrap over the years, it’s important to understand the in’s and out’s of how loan repayments work before making a decision.
Principal and Interest vs Interest Only Loans Explained
As a general rule, the average Australian makes repayments on their home loan on the principal balance – or how much they’ve actually borrowed – plus the interest accrued on that loan too. This process is commonly referred to as principal and interest repayments.
In contrast, and depending on your own financial situation, some lenders may allow homeowners to make repayments on their mortgage that is based on the interest only – not the principal. While the weekly, fortnightly or monthly repayments are smaller this way, eventually the principal balance does need to be paid back. It’s for this reason that interest only repayments are usually capped, typically for up to five years.
The latter in particular is notably popular amongst property investors. It allows them to build their property portfolio, wait until the property’s value has risen enough to cover the amount they’ve paid in interest, before often proceeding to sell the property at a profit – all without paying anything off the principal of the home loan.
The bonus here is that the amount of interest they have paid is also tax deductible, but it can be a risky roll of the dice if anything were to go south in regards to the property’s value. When the interest only period ends the repayments are also likely to be higher, as the homeowner will need to start paying more in order to pay back the principal balance and interest within the time period initially set for the loan, such as twenty or thirty years.
In comparison, principal and interest loans are usually considered to be the go-to option for owner occupiers, and first home buyers. It’s seen as less risky in the eyes of most lending providers, which in turn often sees them offering lower interest rates than what is usually issued on interest only loans. Since the scheduled repayments chip away at both the principal amount and the interest owed, homeowners usually wind up paying less interest over the lifetime of the loan than what they would when compared to an interest-only loan.
If you’re unsure as to which option is best suited to you when comparing the different pro’s and con’s associated with principal and interest vs interest only loans, then it’s always a good idea to speak to a professional before you commit to the loan’s terms. Your own individual circumstances and your financial goals will be large influences on what is determined to be the ‘best’ choice for you, as neither option should be viewed with a one size fits all approach.
Taking The Stress Out Of Home Loans
The big attraction of buying your own home is just that – it’s yours, once you’ve paid back the banks of course. Apart from having somewhere to live, the quest for home ownership is also about having a long term investment strategy. If we’re looking at it from the viewpoint of decades instead of months, generally house prices do rise, and so does the value of your investment.
With a background in banking, finance, business development and project management, there’s no better advocate to have on your team than Nikki Berzin. As a fully qualified mortgage broker and director of Cherry Lending & Finance, Nikki is passionate about all things finance, and empowering her clients with the tools to hit their property goals is what she does best.
If you’re looking to get into your first home, purchase an investment property or even want to look at your options for refinancing, the first step is starting the conversation. Get in touch with Nikki today, or call her directly on 0427 374 155 to bring your mortgage dreams to life.
Disclaimer: Your full financial needs and requirements need to be assessed prior to any offer or acceptance of a loan product. Subject to lenders terms and conditions, fees and charges and eligibility apply.
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