So, you’re looking to purchase your first home and you’re exploring the whirlwind of home loans and finance. There are many different loan types available for any individual circumstance, but it’s important to understand what you’re paying off when you’re making your repayments and what the consequences and benefits are of each type of mortgage repayment.
Generally, mortgage repayments cover the principal and interest, however, interest only home loans do exist. There is a wide choice of mortgage repayment options including interest-only home loans. We explore some of the options in detail below.
Principal and Interest Home Loans
A principal and interest loan is a traditional mortgage where you pay the principal, which is the original amount you borrowed, as well as the accrued interest. This can be a cost-effective option as you’re reducing your principal over the life of the loan, meaning your interest is regularly calculated based on the amount owing at that time.
Pros of a Principal and Interest Home Loan
- You are making repayments on your loan from day one.
- Even if you only pay the bare minimum, you will pay less in interest over the term compared to an interest only loan.
- You may be able to borrow more than you would on an interest only loan.
Cons of a Principal and Interest Home Loan
- Your repayments are higher than an interest only loan.
- This may be an unsuitable option for investment loans.
Interest only home loans
With an interest-only home loan, your repayments cover just the interest, not the principal. This means you are paying nothing off the amount you initially borrowed so your principal loan amount remains. Only at the end of the agreed period of your mortgage do you repay the principal and then you repay it in full.
Pros of interest only mortgages
- Monthly repayments are lower than a normal ‘principal and interest’ mortgage.
- These may be useful for short-term loans like a construction loan or even bridging finance.
- If you are an investor, you may have the option to claim higher tax deductions from an investment property.
Cons of interest only mortgages
- You will typically pay more in interest over the full term of the loan. However, most people who take out an interest-only home loan sell the property well before the end of the loan term. Their plan is generally to keep the property just long enough to make an attractive capital gain (i.e., sell it for much more than they paid).
- Your repayments will increase after the interest-only period and you may find that your mortgage is unaffordable.
- If the property doesn’t increase in value during the interest-only period, you haven’t built any equity which can be risky if you plan to sell or if there is a market downturn.
Key Things to Keep in Mind
Neither type of loan is ‘bad.’ As outlined, there are both pros and cons for each type of loan and your mortgage broker will be in the best position to guide you on which mortgage repayment option is best for your situation.
If you do decide to choose an interest-only loan, it’s worth calculating how much your repayments will be at the end of the interest-only period to make sure you can comfortably afford these repayments and there are no nasty surprises.
Purchasing a home is one of the biggest purchases you will make within your lifetime and it means you need to think about the future as well as your current position. Planning will give you breathing room and it will mean you’re likely to be in a better position in the future.
Mortgage repayment types aside, we have explored other key loan features and commonly asked questions that may help you choose the right mortgage plan for you.
Should I Make Monthly, fortnightly, or weekly mortgage repayments?
Many people pay off their home loans on a monthly basis because they get paid monthly. However, it is possible with some loans to make mortgage repayments on a fortnightly or weekly basis, and this could cost you less over the term of your home loan. When you make your repayments fortnightly, you end up paying an additional month per year due to there being 26 fortnights annually, not 24. Essentially, this means that you might not only save money in the long run, but you might also reduce the time you pay off your mortgage.
What is a Redraw Facility?
A mortgage with a redraw facility is specifically designed to allow you to make additional repayments and redraw them at another time if you need to.
What is an Offset Account?
An offset account is a transaction account that’s linked to your home loan account. It can provide you with more flexibility and potential savings as it means that instead of being charged interest on the full loan balance, interest is charged on the loan balance minus the amount that’s in your offset account.
What is a Repayment Holiday?
Some loans have a repayment holiday feature which is essentially the option to have a short, temporary break from paying your mortgage in the event you need to direct your cash elsewhere. If you’re ahead of your mortgage, lenders may provide repayment holidays of up to 12 months. However, there may be additional interest costs which are worth considering. In this instance, we recommend speaking with your broker before pursuing this path.
If you’re looking for some guidance around what type of mortgage repayment will work best for you, please get in touch with our friendly team for a no-obligation chat. We understand that while this can be an exciting period in your life, it may also be overwhelming. We believe it’s our role to not only guide you through this process, but to also ensure you feel informed at every step of the way.