Interest-only mortgages - a growing phenomenon
As the high demand and low stock levels drive prices around the country, property purchasers are increasingly considering the option of interest-only mortgages. For those new to the mortgage market, it’s important to understand the difference between a regular mortgage and an interest-only one – and the potential pitfalls. The benefits of an interest-only mortgage include:
It’s cheaper – you’re only paying the interest amount on the loan, hence your weekly, fortnightly or monthly payments exclude any component of payback of the principal
- Because of the payments being less, it can allow purchasers to service a larger loan amount and free up cashflow
- It’s an efficient way for investors to finance properties as they can claim the interest as an expense, but not the principal repayments
- Investors seeking capital gains often favour interest only, as they’re interesting in making gains purely on the increasing value of the property rather than anticipating paying off the loan gradually
- It can free up money for renovation of a property
- Should a purchaser suffer a sudden drop in income, switching to an interest-only mortgage can help them through a difficult, short-term period
Of course, it’s not all good news. The primary issue with this type of mortgage is that the principal loan amount doesn’t reduce over time. In the event that property values take a downturn, owners can be caught out by the value of their asset becoming less than the amount owed on it, taking them into negative equity. Or in another scenario, lenders can become uncomfortable with the loan-to-value ratio and force a sale. Banks generally only agree to interest-only loans for a maximum period of five to seven years.
If you’re thinking of opting for an interest-only loan, take the time first to thoroughly investigate both sides of the coin – they can certainly work well in some situations, but aren’t recommended for everyone.