If you’re the indecisive type, chances are you’ll run into a more than a few confusing crossroads when buying a new home. One of the choices that may leave you scratching your head is whether to take out an interest-only loan.
A what loan?
According to Walshs specialist mortgage broker Donna Sutherland, an interest-only loan sees the borrower pay interest on the mortgage instead of both the interest and the principal (aka the actual amount you’ve borrowed from the bank).
“It essentially means your monthly mortgage repayments are considerably lower because you’re not paying anything off the loan itself,” Donna says.
“Generally, lenders will accept two by five-year terms – so they’ll accept one five-year interest-only term but when you go for your second, they’ll start to ask questions,” she says.
More cash in your coffers!
The main reason people opt for the interest-only path is to save money in the short-term by reducing their mortgage repayments.
It works well, Donna says, for property investors because the interest can be claimed as a tax deduction.
“Most of our clients are doctors who have a guaranteed steady income yet pay hefty bills at tax time,” she says.
“If they’re not already investors, it’s a good way for them to get on the property ladder because the entire portion of their interest-only repayments are tax deductible, which in turn reduces their total tax bill.
“And if the property increases in value, by the time they come around to paying both principal and interest they will have built up an equity buffer.”
It’s also an appealing interim strategy for cash-strapped first homebuyers, those looking to free up extra money for home renos or business ventures, and for anyone who may be on a reduced wage for a period of time, e.g. parental leave.
“You might have upcoming expenses or time off work so you could flip the loan to interest-only for a year or two then ramp it back up when you’re on top of things.”
“Yes, you’ve taken two years out of repaying your mortgage, but you’ve given yourself some breathing space.”
Sounds like a goer, right?
Saving cash upfront might sound pretty lucrative, but Donna says you still have to pay the piper.
“Normal lending usually runs over 30 years and if you take two five-year interest-only periods, you’re not reducing the lending at all. Instead, it all gets crammed into 20 years because for 10 years you weren’t paying off the loan.
“It’s a double-edged sword; it works well if your income’s increasing and you can afford higher repayments at the end, but you might be in for a shock when you come to the end of the interest-only period and your repayments increase”.
“That’s why it’s vital to have a final exit strategy – you need to know how you’re going to pay out the loan in the end, either by higher repayments, selling the property or using savings.”
A clear direction
Still ambiguous about the way to go? Fear not!
As an accounting firm, financial planning service and mortgage broker all rolled into one, Walshs takes the guesswork out of structuring your loan.
“Typical mortgage brokers don’t have an affiliation with accountants or financial planners; they can’t give you tax advice or tell you how to build a property portfolio or structure your debt,” Donna says.
“A big benefit at Walshs is that when a client comes in, they sit down with a financial planner and an accountant to work out their long-term financial goals, and we as brokers then help them find the right loan.”
To discuss your current and future home loans, simply drop us a line on (07) 3221 5677 or book a 1-1 meeting.