Interest-only (IO) home loans are a popular alternative to traditional mortgages as they allow borrowers to pay only the interest on their borrowed amount for a period of three to five years, resulting in lower monthly repayments during this time. However, it is important to weigh the advantages and risks of these loans before deciding whether they are the right option for you.
Pros of IO Loans
Advantages of IO loans include lower repayments during the interest-only period, which can help borrowers to free up cash for unexpected expenses or to invest in renovations or other projects. This type of loan can also be useful for borrowers who expect their income to increase in the future, as they can afford to make higher repayments later.
Cons of IO Loans
While IO loans may seem like a good deal initially, they also have some risks that borrowers need to consider. One of the biggest risks is that when the interest-only period ends, the borrower will have to start repaying the principal and the repayments can increase significantly. This can be particularly difficult for borrowers who have not planned for the increased repayments. IO loans can also extend the overall mortgage term, as borrowers will have to pay off the principal over a longer period of time. Furthermore, some lenders may charge higher interest rates for IO loans compared to principal and interest (PI) loans.
IO Loan Expiration: How to prepare for it
Before taking out an IO loan, borrowers should carefully consider what their full repayment amount will be once the loan expires. This will allow them to adequately prepare for the higher repayments that will be required. It is also important to note that interest rates may rise over time, resulting in higher repayments than anticipated. To prepare for this, borrowers may want to consider making higher repayments ahead of time or refinancing their loan altogether.
IO loans can be a good option for certain buyers, particularly investors. However, borrowers should be cautious not to purchase a property that is beyond their means, as IO loans will eventually revert to PI loans unless the property sold prior. To avoid any surprises, it is important to carefully read and understand all loan documents before signing. If in doubt, it pays to ask questions so you're clear on your loan obligations.
* This information is general in nature and not intended to be financial advice.
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