Interest-only loans: friend or foe?

WITH THE UFINANCIAL TEAM

Refinancing numbers have increased by 13.8 per cent year-on-year in response to recent rate hikes.

With about $370 billion worth of mortgages due to come off fixed rates in 2023, these numbers are expected to increase as Aussies actively search for ways to mitigate the impact of rising rates.

Some have reviewed and reduced their living expenses, some have started making additional repayments on their home loan, some have deposited money into their offset account, and others have sought alternative options to reduce their repayments, such as refinancing their current principal-and-interest (P&I) loan into an interest-only loan.

The latter leads us to the main topic of this article.

Is refinancing your P&I loan into an interest-only loan a smart move?

Interest-only home loans allow borrowers to only pay interest on the balance they have borrowed for a specific period (usually five years) and then the loan reverts to a P&I home loan.

As an example, if you had a $500,000 interest-only home loan, the repayment amounts would only cover the interest owed on the principal during this five-year period. That means your repayments would be lower, but you would still owe $500,000 at the end of the five-year period.

While most people are completely for paying off debt and reducing debt as quickly as possible, interest-only loans can be a helpful tool for investors and even owner-occupiers who have other higher-interest outstanding debts such as credit cards or personal loans.

If you’re an investor, there are some potential tax benefits to having an interest-only home loan. In addition, lower repayments would give you more cash flow. The money you save on the mortgage repayments could be invested elsewhere – in the property itself or in another investment.

However, things can be a bit tricky if you’re a homeowner.

Traditionally, interest-only loans have been designed for investors to reduce their mortgage repayments, and maximise their tax benefits and return on investment (ROI).

That doesn’t mean owner-occupiers can’t refinance to an interest-only home loan. However, lenders which may consider refinancing will have strict lending criteria, and will require a valid and strong reason for refinancing to interest-only.

Any big financial decision should not be taken lightly.

A mortgage broker or a financial adviser can advise you on whether a refinance with interest-only would benefit your long-term goals.