In the current environment with rapidly rising interest rates, one of the common questions we have been asked by clients is whether they should switch current principal and interest loan to interest only loan(s) as a better option?
The answer is neither a simply yes or no, as it will depend on individual financial goals, purpose, and situation. I have summarised a few general benefits of an interest only loan option and also things you need be fully aware of when applying for interest only loans. I hope it will help you gain some general knowledge about interest only loans.
There are three main benefits from my point of view –
The first benefit is assisting with cashflow, especially for investment properties loans, the loan repayment might largely rely on the rental payment, with an interest only repayment, it helps you manage the cashflow and release the higher loan repayment pressure especially in the current rising interest rates environment.
Secondly, tax benefits, for business purposes lending or investment properties lending, all associated interest costs might still be able to be deducted as expenses from the business (we recommend you seek independent tax advice to work out the best option).
Thirdly, it might help you to manage overall lending strategy/ asset planning better, say if you have some higher interest rates lending as well as home loan(s), it might make more sense for you to focus on paying principal and interest on those higher interest loans first, since home loan interest rates are lower, you might wish pay interest only on home loans.
Another example, say if one of your asset planning goals is to repay your owner-occupied home as much as possible and eventually discharging it in the future as a mortgage-free property, then your strategy might be interest only on those investment property loans while concentrating on paying principal on the owner-occupied home loan. (We recommend you seek independent legal advice whenever required).
Things you need be fully aware of when applying for interest only loans
Firstly, it will be a new full lending application.
Applying for an interest only application, including switching a current principal and interest loan to an interest-only loan, or extending an existing interest only loan for a further period, a full application assessment will be required, just like applying for a new loan (subject to the current lending criteria). Therefore, there is no guarantee it can be approved.
As always, we will be happy to help you to review if you are meeting bank’s current interest only lending policy and do an assessment for you if interest only will be a better option.
Secondly, for those clients who require to have their max borrowing capacity, there is a hard balance in between maximum and your lending capacity while meeting interest only higher servicing requirement.
The reason is that when you choose interest only, the lenders will need to assess the application in a situation when the interest only expiries, the clients will still be able to meet the servicing requirement within the remaining term.
For example, if you apply for five years of interest only with total term of 30 years, the lender will need to assess total term 25 years to pay principal and interest rather than over 30 years, which required higher income to service the same level of debt. In other words, the Principal and Interest payments after the end of interest only payment period will be higher than they would have been if the loan had Principal and Interest payment through the total term.
Generally, if your goal is to borrow as much as you can, you will need to reduce your interest-only term or even give up an interest only option.
Thirdly, please be aware of that by not paying off principal will result in more interest being paid over the loan term, it also means that the amount of equity that can be built-up in the home will be less with an interest only home loan than with a Principal and Interest home loan.
Disclaimer: we recommend that you seek personalised professional advice from your trusted adviser before taking any action as each applicant’s situation can be vary, the above content is only general commentary.
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