Interest only loans are becoming increasingly popular. ASIC data indicates that one in four owner-occupier loans in Australia is now interest only, and two out of three investment loans.
With an interest-only loan, the lender issues a standard mortgage but agrees to a term in which the borrower pays only the interest, which means monthly repayments are lower than a traditional principal and interest loan. Over the term of the interest-only loan, the loan principal is unchanged.
One of the main benefits of paying interest-only on a loan is that the repayments will be smaller. For home buyers, this is a brilliant opportunity to use these savings to pay down other higher interest loans before reverting your attention back to the home loan. For investors, the extra interest paid can have tax benefits i.e. interest can be claimed against income to reduce the taxable amount.
The most important thing to remember when choosing interest only is that the principal will not reduce. If your property does not increase in value, neither will your equity, and if your home decreases in value you could be left paying a mortgage that's worth more than your property.
Additionally, you will pay more interest over the life of the loan, and you'll eventually have to pay the principal. However, for your average home buyer an interest only loan can be a great short-term strategy.