What should you do when the interest-only period ends?
Interest-only home loans are often used by investors for a number of reasons and recent statistics show that there has been a strong shift towards these home loans for investors.
According to the Australian Prudential Regulation Authority (APRA), the value of interest-only loans grew by more than 14 per cent in 2014 to September 30. Also, in the September quarter alone, the number of residential interest-only loan approvals reached 42.5 per cent.
There are a number of reasons why property investors often choose the interest-only option for their investment properties. As the loan on the investment property is tax deductible debt, investors are often advised just to pay the interest and thereby receive an interest tax deduction for exactly what they pay. By not having to pay principal initially, it also allows them to put extra money towards their non tax deductible debts and funding other assets. Particularly, when borrowers first get into property investing, it also allows them to pay the minimum and can assist when cashflow is tight in the initial years.
Other investors will choose a principle and interest loan from the start as they want to build up equity in their property regardless of whether they will receive a tax deduction for their entire repayment. This is a more conservative approach and will depend on you financial goals so getting financial advice from a qualified adviser is recommended.
So what is an interest-only home loan? Simply put, borrowers only have to pay the interest for the period as well as any fees for a fixed period of time, usually five to 10 years. Therefore, during this period, the repayments are a lot lower compared to a principal and interest home loan. Then, once the interest-only period ends, the home loan will revert back to a principal and interest home loan over the remaining term. For example, if it was a 30 year loan initially and 10 years interest only has passed, the new principle and interest repayments will calculated over 20 years which could be quite a large increase in repayments. This can often catch borrowers off guard if they forget that the interest only period is expiring.
Once the interest-only period ends, there are a number of options that you can take.
Extend the interest-only period
Depending on your lender, this may or may not be an option. Most lenders will want to keep their customers and will try to accommodate their needs as much as possible. If you do wish to extend the interest-only period, your lender may have to complete another credit assessment to ensure you are still able to meet the repayments. You may want to start this process 3 months before the interest only period expires to give you plenty of time to get it arranged.
Before moving ahead with this option, you will need to think about how it will affect your finances down the track. It is a good opportunity to review your investment strategy with your accountant or financial planner to ensure that continuing to pay interest only is the best option for you.
Refinance to another loan
If you are coming towards the end of the interest-only period, it is a great time to start researching the market for what other options are out there. You may find that there is another home loan that is more competitive and/or has more features to suit your needs. Also, if you are interested in extending the interest-only period, you may be able to do so at a better rate.
Stick to the principal and interest loan
This is probably the simplest option as you don’t need to do anything but increase the repayments you make each month. By reverting to a principal and interest loan, it will enable you to start paying of the home loan and build up equity in your investment property.
If you would like to speak to someone about your options for an interest-only home loan, please contact our friendly team on 1800 111 001 and we can help discuss your options.