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What are ‘interest only’ loans?

Research released by the Australian Prudential Regulation Authority (APRA) at the end of last year showed that Interest Only loans are becoming increasingly popular, now making up almost 40% of all residential home loans.

What is interest only?

Mortgage repayments are generally made up two components – the principal (the sum you’ve borrowed) plus interest charged by the lender.

But on an interest only loan, the repayments you make are only interest payments and there is no imperative to pay back the principal.

Typical interest only loans are available for up to 5 years. They’re great in many circumstances, for example, for investors – who have plans to sell within a certain period. Or for anyone who has purchased a new home but is still in the process of selling an old one. Or for people going through a cycle of lower than usual income.

But for home owners – and especially first time buyers – there is a good reason to think carefully before leaping into an interest only loan.

Interest only loans can seem tempting because repayments are lower than ‘normal’ mortgage repayments and if you’re good at saving you can use the extra cash in other ways that benefit your lifestyle. Plus, most interest only loans let you make extra ‘bonus payments’ whenever you like, so you can – when it suits – pay a lump sum towards the principal.

But – and here’s a word of caution – when you’re only paying back the interest and not putting a dent in the principal on a regular basis, you’re not actually making any significant headway on your loan, and building up equity, or what I like to call ‘skin in the game’.

Equity is the amount of money you ‘own’ – the bit you’ve paid back. It’s your stake hold, (calculated by subtracting the loan amount from the property’s market value) which can be used to leapfrog into a bigger, better home when you start a family, or to renovate, add on a room for teenagers or ageing parents, or just deal with whatever changing circumstances you might encounter.

It’s important to think of equity as a kind of enforced saving plan because if you knuckle down, pretty soon those mortgage repayments that seemed a bit daunting at first will become easier and then before you know where you are, you will have built up your equity which you can tap into when the need arises.

For more information, contact us here. Everyone’s needs are different and I can help find the right loan for you.

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