Interest only (IO) home loans are a popular choice among property investors as they can help maximise short-term cash flow and tax benefits. However, when the IO period ends, you’ll be saddled with increased repayments and the likelihood of paying more interest overall.
Many lenders will provide you with options to extend your IO loan, depending on your circumstances. In this article we’ll explain what IO loans are, and whether you should consider extending your IO period.
An interest only home loan is one where for an agreed upon period of time, you are only required to make repayments on the interest that accumulates on top of your mortgage. This means that during the IO period, you don’t have to make any repayments on the principal (loan balance).
The main benefit is that you are paying less month to month and have an increased cash flow. This means you have more funds to spend on investments and other purchases. IO loans are considered riskier, so lenders may be stricter with who they lend to.
Property investors often prefer IO loans more than owner occupiers do. This is because property investors are eligible for more tax benefits than owner occupiers. They are also more likely to maximise their investment opportunities during the IO period.
Property investors get to claim their interest repayments as tax deductions, whereas owner occupiers cannot. Interest rates for IO loans, especially investment loans, are often higher than standard principal and interest (P&I) rates. Make sure you shop around and compare the rates from different lenders.
In a general sense, those who are wanting lower mortgage repayments could consider IO. There are other ways to reduce your mortgage repayments. Notably, you could seek out a lower interest rate.
Whether you want to find a competitive IO rate or a better P&I rate, you can compare interest rates from over 35 lenders using Lendi’s online platform. Try it out here:
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Extending IO can be a good option for investors wanting to keep expenses down so that extra funds can be diverted into new investments.
Some investors will intentionally purchase a property in a high growth area to sell in a few years for a profit (capital gain) as the property’s value increases. By opting for an IO loan, you have the potential to make a lot of profit without even paying off the principal at all.
With some lenders, your borrowing power will be reduced because they’ll consider whether you’ll be able to pay the loan back after your IO period ends. For example, they’ll assess whether you can repay the loan balance on a 25 year loan with a 10 year IO period. This effectively gives you only 15 years to repay the principal after the IO period ends.
Of course, there are options to refinance to a longer loan repayment period, but that only adds to how much interest you’ll pay. Lenders may be hesitant to provide significant extensions to interest only mortgages, as it means that you aren’t paying off your loan at all.
Those who are on IO loans because they believe they’ll benefit from eventual capital growth when they sell could be at risk. Property prices can be volatile, so this isn’t a risk-free move. If you’re opting for this strategy, try to buy in an up-and-coming area to maximise your potential property value growth.
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If you only want a minimal extension (e.g. 2 years), it’s possible that you can just get in contact with your lender and ask. They are likely to grant it if you’ve made your interest repayments consistently on time and are classed as a low risk borrower.
You may have more difficulty requesting an extension as an owner occupier. This is because you may be perceived as ill-equipped to handle increased repayments when your IO period eventually ends. To get an IO extension, owner occupiers will need to have a good reason.
If you’ve already extended your IO loan a couple of times, you also are less likely to be approved for an additional extension.
If your current lender won’t approve an extension, you may be able to refinance to another IO loan with a new lender. You can compare IO loans from Australia’s top lenders online with Lendi.
With a principal and interest (P&I) loan, you will be required to repay both the interest and balance of your home loan. You’ll be reducing the debt you owe, and therefore you’ll be closer to owning your property.
While your repayments will increase, you can try to negotiate a better interest rate with your lender. Interest rates are at historical lows right now, so you should be able to find a good deal. If your current lender isn’t offering you competitive rates, it may be time to move on and switch lenders. Typically, P&I interest rates are lower than IO rates.
Another benefit is that you’ll build equity faster, which increases your chances of making a solid profit when you sell. Equity can also be used for a variety of other purposes, such as making new investments or to renovate your kitchen.
If your lender won’t approve you for an IO extension and you can’t afford P&I repayments, it may be time to seek assistance. Get in touch with your lender’s financial hardship team and they will help you as much as they can.
They may be able to provide a conditional 1 year IO extension, or extend your overall loan term to reduce your repayment size. They will come up with a plan and provide case-specific advice to you.
You also have the option to sell your property. If it’s your primary place of residence, you may be able to downsize. If it’s an investment property, you could purchase a cheaper one if you can afford to do so or just let it go.
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The information in this post is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.
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