Interest only V’S Principal & Interest – What’s the difference?
In light of the current low interest rates, many of our clients have been asking us whether it is better to adopt interest only (IO) or principal & interest (P&I) repayments on their loans. On face value, paying P&I makes sense when rates are low, as it allows you to repay the loan faster. However, there are situations when IO may be the better strategy to adopt. Firstly, let’s clarify how they both work.
With Interest Only repayments, you are only required to repay the interest portion (plus any fees) on the loan over the chosen Interest Only period offered by the lender. Upon expiry of the original IO period (usually from 1–5 years), you must request and negotiate a new Interest Only term if desired. To ensure you are not caught out, it is important to know what your lender allows at the Interest Only term’s end before it comes around.
Principal & Interest
Principal & Interest loans are designed to repay your loan over the defined loan term – usually 30 years. Your lender calculates your repayments including the interest charged for the repayment period and any loan fees, plus a portion of the principal balance. Under Principal & Interest; as your loan balance reduces, so does the interest component (assuming the interest rate remains constant), meaning your scheduled repayment pays off more of the loan principal, as the loan term progresses.
When can Interest Only help me?
There are some situations where Interest Only can benefit you, for example if you are a First Home Buyer that is building. The time that the home is being constructed the repayments are usually set at Interest Only, this can be extended to be anywhere from 1-5yrs in total.
If during the term of the loan your work situation changes for a short period of time, for example if a woman is going on maternity leave for 1yr, this can also be a time for Interest Only repayments.
You also need to keep in mind that over a 30yr term most banks will not let you do more than 5yrs of Interest Only repayments, so if you feel you need this please discuss it with your broker before you make any decisions.
What Should I Choose?
This is where it is best to sit down with your broker and discuss your current financial position and where you wish to be in the next 3 – 5yrs. No one can predict what the cash rate will do with the government, nor can they predict what the banks will do if they choose to do a rate increase or decrease. So, make a plan with your broker and they will help find the best suitable option for you.
Call our friendly brokers here at Blue Wave to have a chat about what is the best option for you and if you are getting the best out of your current rate. Either call the office on 07) 5443 8773 or drop us an email HERE