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Interest Only Loans

June 29, 2024

Another week, another round of bad news regarding Australia’s inflation data. Insurance premiums as it turns out, are a significant contributor, with premiums increasing by 14 percent over the year to May.

This increase is the highest among all expenditure categories. Median home and contents insurance premiums surged by more than 19 percent in the last 12 months, reaching $2,434. Why? The sharp rise is attributed to inflation in the building sector and a spike in natural disasters.

The knock on is that higher premiums are captured in the inflation figures which puts pressure on the RBA to increase the cash rate, and of course, elevated premiums put more homeowners at financial risk, with some opting not to insure their properties due to unaffordable premiums.

It continues to be a tangled mess and I’m not convinced we as consumers have much control over inflation at this stage – we are simply the victims of it.

In this week’s newsletter, we take a look at the governments recent announcement regarding changes to the banking system to help customers get a better deal from lenders.

Interest-only home loans can be beneficial, but like most things, where there are pros there are also cons. They certainly have a place in the market but they are not suitable for everyone.

Pros

  • Lower Initial Payments: During the interest-only period, borrowers only pay interest, resulting in significantly lower monthly payments compared to principal and interest loans. This can free up cash flow for other investments or expenses.
  • Tax Benefits: Interest payments on investment properties may be tax-deductible, offering potential tax advantages for investors using interest-only loans.
  • Potential for Further Investment: For investors, the lower payments mean more funds can be allocated to other investments, potentially leading to greater overall returns across an investment portfolio.

Cons

  • Higher Long-Term Costs: Eventually, the loan must be repaid, including the principal. Once the interest-only period ends, monthly payments can increase substantially, leading to potential financial strain.
  • No Equity Build-Up: During the interest-only period, borrowers do not reduce the principal loan amount, meaning they do not build equity in the property if property values remain flat.
  • Risk of Negative Equity: If property values decline, borrowers may owe more than the property is worth.
  • Potential for Financial Mismanagement: The lower payments might tempt some borrowers to overextend themselves financially, leading to difficulties when higher payments kick in after the interest-only period.

Who are the best suited to?

Investors are particularly well-suited to interest-only home loans because these loans offer lower initial payments, freeing up cash flow for other investments. This can enhance an investor’s ability to diversify their portfolio and potentially increase overall returns.

Additionally, the interest payments on investment properties are often tax-deductible, providing a further financial advantage.

The flexibility of interest-only loans allows investors to strategically allocate funds, maximise cash flow, and respond to market opportunities more effectively. However, careful planning is essential to manage the eventual transition to higher payments once the interest-only period ends.

Variable

The rates below are based on a $500,000 loan, with the borrower making principle and interest payments with a loan term of 30 years. The rates quoted may vary depending on the borrowers LVR.

1 Year Fixed

The rates below are based on a $500,000 loan, with the borrower making principle and interest payments with a loan term of 30 years. The rates quoted may vary depending on the borrowers LVR. At the end of the three year fixed period, the borrowers interest rate will revert to a standard variable rate for the life of the loan.

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