Interest only loans, why and what does it mean?

Under an interest-only loan, the borrower is not required to make principal repayments during the interest only term – basically the only requirement is to pay the interest which is due on the daily outstanding balance at the end of each month.

These loans are usually for a short period of around 1 to 5 years, and because you are not making principal repayments they must be approached with eyes open.

Have you wondered why interest only loans exist?

Why would you choose an interest only loan?

Typically only used by investors or where cashflow is tight for a short period of time, an interest only facility can maximise an investors cashflow which could mean they can hold more properties and hopefully make a bigger profit from the future sale of all of them. An investor will also cleverly use an offset account against their investment loan if they have paid off their own home, or, if they have bought an investment before buying a home and they plan to save for their deposit here.

Like all financial decisions it has to suit your goals and needs now and for the future – and that includes understanding how you’re going to make the ongoing repayments when you’re thinking about taking an interest only loan. You now have only 25 years left in a typical loan term which means that unless you refinance you will be paying higher repayments to cover the principal over a (now) shorter term. Again, this may suit your cashflow and goals perfectly.

Beware also that lenders are aware of this and will test your ability to make the repayments, at the higher buffer interest rate, over the 25 year term as well – which actually can now make proving affordability a tougher prospect.