Interest Only (IO) – Is it a Good Choice?

With most loan repayments, you have two options: principal and interest or interest only.
It is important to understand what interest only payment is and how it works. What is the rate and what advantages and disadvantages you may have. You need to think about it before making a decision

What Is Interest Only Payment?

With interest only payments, you only need to pay the interest portion of the loan for a set period, such as the first or five years, not the amount of the loan itself (principal). This will result in lower monthly repayments for a set up period. Eventually, you’re not making payments on the “principal” for that period of time.

The maximum time most lenders provide for interest only is five years for owner occupiers or investment loans. After this period, the loan reverts to principal and interest repayments. You will face a higher monthly payments with principal and interest.

How does Interest Only Payments Work?

Monthly payments for interest only is lower than payments for principal and interest loans. That is because you only pay interest without any principal payments.  Therefore, by the end of the set up period, the balance of the remaining loan has no change.

To calculate the monthly payment for interest only loan, multiply the loan balance by the interest rate, then divide by 12 months. If you owe $500,000 with 3% interest per annual, your repayment would be:

$500,000 * 0.03 = $15,000 p.a / 12 = $1,250 p.m.

Advantages and Disadvantages of  Interest Only Payment

 

Advantages:

• Lower mortgage payments for set period, to suit your lifestyle;
• Keep costs low may help for to buy more expensive property;
• Free up cash flow could be helpful if you need spare cash for other purposes;
• Investors, may claim the interest payments for tax deductions.

Disadvantages:

 

• Principle amount can’t be reduced during interest only period;
• Face higher interest rate during interest only period;

Your repayments will eventually go up;

• More expensive in the long run;
• Less equity in your property.

Is Interest Only Payments Worthwhile?

Interest only isn’t necessarily a bad idea.  It depends on how you use. If you have a great financial strategy on how you will use the extra money, then they can work well.

It is important to understand between actual benefits and the temptation of a lower payment. Interest only works when you use them as part of a sound financial strategy, on the other side, it may cause long term of financial problem if you just use interest only payments to buy or expend more than you can afford.

If you need to further discuss interest only repayment, please contact us.  We will help you to check your strategy and step by step to evaluate whether it is suitable for you.