P&I is more commonly used by owner occupiers because the principal balance is paid off right from the start of the loan, and brings them closer to the debt-free, homeownership dream. On the other hand, IO loans tend to be a more popular option with investors who take advantage of the lower repayments with the intent of selling the property in a few years.
IO loans generally have a set term between one to five years where – as the name states, only the interest is paid. But once this period ends, it will be rolled over to a P&I loan structure where it will be repaid over the remaining term. Generally, borrowers end up paying more interest throughout the lifetime of a loan that starts as interest-only. However, with monthly increases to the interest rates and continued inflationary concerns, switching to an IO repayment type could be an option to free up short-term cashflow.
We take a look at some ways IO loans can help homeowners and discuss some things to consider.
How it can help:
Lower repayments
As mentioned above, one of the most significant reasons for an IO loan is to reduce your repayments each period. Cashflow may become easier to manage for a fixed period of time while interest rates and inflation continue to rise.
Flexibility
Households with an irregular income may choose to switch to an IO loan until their income stabilises. Furthermore, borrowers are still given the option to pay off some of the principal amount during this IO period.
Other opportunities
An interest-only loan allows borrowers to invest their money elsewhere, such as stocks, bonds, or other properties, as they only have to pay the interest amount for a specific period. This could be an attractive option for those who want to diversify their investment portfolio.
Things to consider:
Higher long-term cost
Although the monthly payments are lower in an interest-only loan, the overall cost of the loan can be higher in the long term. As borrowers only pay the interest for the initial years, the principal balance remains unchanged, and interest charges continue to accrue. Therefore, once the interest-only period is over, the borrower’s monthly payments will increase significantly, and the remaining principal will need to be paid off over the remaining loan term.
Limited eligibility
Interest-only loans are not available to everyone. Lenders may require borrowers to have a higher credit score, a larger down payment, and a lower debt-to-income ratio to qualify for an interest-only loan.
Risk of home foreclosure
Interest-only loans are considered risky for borrowers who do not have a clear plan to pay off the principal balance once the interest-only period ends. If the property value declines, the borrower may end up owing more than the property is worth, making it difficult to refinance or sell the property.
In conclusion, an interest-only loan can be an attractive option for those who want to lower their monthly payments for a limited time. However, it’s crucial to weigh the pros and cons of an interest-only loan and speak with a financial advisor or mortgage broker to determine if it’s the right choice for your unique financial situation.
Any advice provided is general in nature and should be considered in line with your financial situation, needs and objectives.
