Home Loan Repayment Types
When it comes to choosing a home loan, one of the options that you’ll need to weigh up is whether to request principal and interest repayments or interest only repayments.
What are principal and interest repayments?
When you pay principal and interest repayments, each repayment goes towards paying off both the amount borrowed to buy the property (the ‘principal’) as well as covering the interest. By the end of the loan term (which can be up to 30 years), both the amount borrowed and the total amount of interest owed will be repaid.
What are the benefits of principal and interest repayments?
Loans with principal and interest repayments have a lower interest rate. Given that a home loan term can be up to 30 years, the amount you could save in interest could be significant.
Another benefit of principal and interest repayments is that with every repayment, you owe a little bit less of the amount you borrowed and are a step closer to owning your home outright.
Other advantages include:
- A lower interest rate when compared to interest only repayments
- You’ll own your home sooner
- You will pay less interest over the life of the loan
- You may be able to borrow more
What are interest only repayments?
Interest only repayments only cover the interest owing on the loan, so none of the principal will be paid off. You can only request interest only repayments for a set term, usually up to 5 years, and at the end of this term the loan will automatically switch to principal and interest repayments for the remainder of the loan, and these repayments will be higher.
What are the benefits of interest only repayments?
The repayments may be temporarily lower at the start of the loan.
If your loan is for an investment property, there may also be potential tax benefits.
Some other considerations for interest only repayments
It’s important to weigh up the following factors when requesting to pay interest only:
- Interest rates for loans with interest only repayments are higher – it’s important to be aware that the interest rate will be higher if you pay interest only instead of principal and interest.
- Increased repayments at the end of the interest only period – because the amount you’ve borrowed will need to be paid back in a shorter timeframe, the repayments will be higher than if you’d opted to pay principal and interest from the outset. The longer the interest only period, the higher the jump in repayments will be.
- You’ll pay more interest over the life of the loan – that’s because there won’t be any reduction in the amount you’ve borrowed during the interest only period.
- You won’t be building equity in your home as fast during the interest only period (equity is the value of your home less the amount you owe on it.)
It’s important to understand the loan repayment option you are planning to request and how this impacts you. Keep in mind the above considerations when requesting interest only repayments. It’s important to ask yourself first if you’ll be able to afford the higher repayments when the interest only period ends and if the short-term benefits of lower repayments will outweigh any long-term costs.
Things you should know
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