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What’s the big deal around interest-only loans?

Eclipse

In your search for the right mortgage, you may have seen or even been offered an interest-only loan, but you weren't quite sure what to make of it. Paying off only the interest rather than the interest and the principal can certainly result in lower initial repayments, but could this kind of loan have some hidden risks for your situation?

Let's take a look at how and why interest-only loans work – and who they work for.

Could your next loan be interest-only?Could your next loan be interest-only?

Living in interesting times

It's no secret that home values across Australia have shot up. For investors who managed to jump on the property market early, this can only be seen as a good thing, but for people trying to buy their first home or take their next step on the ladder, it can be a serious barrier. Despite the record-low interest rates as a result of the lowered official cash rate, there will still be plenty of people out there looking to make their mortgage that much easier to service.

For this reason, interest-only loans might appeal. Typically, taking on one of these loans means you will only be paying off the interest on your loans for a set period, maybe five or 10 years. At the end of this period, you revert to a standard principal-and-interest loan, and your repayments increase as a result.

Staying invested

Because the initial repayments are lower, an investment loan is that much easier to service.

These loans have proven popular due to the ease of dealing with your budget, but they are particular favourites of property investors. The Reserve Bank of Australia records that more than half of the investor loans approved over the last few years have been interest-only.

Because the initial repayments are lower, an investment loan is that much easier to service, making it possible to rapidly expand a portfolio and get your share of the capital gains in property hotspots. However, this makes it all the more important to pick your properties wisely, due to the fact that as soon as your honeymoon period expires, you will be back to higher repayments. Hopefully, by then, your property will have accrued enough value to have been worth the risk!

Interest-only loans aren't suitable for everyone, but they could be a useful tool in your wealth building arsenal. They could even be the key to a secure retirement further down the line. If you want to find out more about your options in mortgages or general financial planning, make sure you get in touch with the mortgage experts at Eclipse Financial Services today!