At different times in the economic cycle, interest only loans are more or less popular. At this point in time with record low interest rates, there can be pitfalls with interest-only loans.
Interest-only loans are where you don’t pay any of the principal of the loan back which make for cheap loan repayments. They are mainly taken out by property investors with 2 in 3 having interest-only loans. Owner occupier interest-only loans are currently at 1 in 4.
What’s the Issue with Refinancing?
This area has received a lot of media attention lately and rightly so as most of these loans were taken out for a five-year period and then they would revert to principal and interest.
The problem is, many homeowners thought that they could just refinance and extend the interest only period. This is not the case now as regulators have cracked down on this area of lending.
The banks are now mostly unwilling to refinance most of these loans, forcing these homeowners onto principal and interest loans that they may not be able to afford.
Large Repayment Jumps
The issue with these loans is that once the initial 5-year period is up, there is a large repayment jump that most people are not prepared for. With no interest rate rises the monthly repayment on a $500,000 interest only loan jumps by $1,401 per month which is $16,812 per year and if interest rates were to rise by 1% the extra repayments per year would be $20,171.16.
Can You Afford It?
Rents and wages have not moved by much in the last few years, so you will have to find that extra $16,812 from your own personal income which most people cannot do. This results in many people having to sell the property. In cities such as Sydney and Melbourne you would have seen enough capital growth to warrant the investment but not every person will be in such a good place. Just look at the negative house price growth in both Perth and Darwin.
So, when looking at financing your home or investment property you need to be aware of these issues and make sure that you have enough spare cashflow to swap from the interest only loan repayments to principal and interest.
Be Well Informed
If you have an interest-only loan or are looking at taking out one, have a look at the links below, so you can be well informed: