While interest only mortgages have come under intense scrutiny across the Tasman over the last year (2017), this type of lending can offer a viable solution for property investors looking to grow their portfolio. Read on to find out more about interest only loans, along with the benefits and risks.
What is an interest only loan?
Most home buyers plan to pay off their home loan as quickly as possible. For property investors however, it can make financial sense to just pay back the interest on their mortgage for a short time, while freeing up some of their investment for other purposes, like renovations to their investment property.
An interest only home loan lets them do just that. Unlike a principal and interest loan where each repayment gradually reduces the amount borrowed along with the interest charged, an interest only loan covers the interest portion of the mortgage only. The principal is then paid in full at the end of the loan period or gradually paid off when the investor switches to a principal and interest loan.
How viable is this type of lending?
Interest only loans work well for investors claiming tax benefits and especially well when the property market is booming, when investors rely on house price increases for equity gains. But this type of lending is not without its risks. It leaves borrowers exposed to interest rate rises because the principal amount doesn’t decrease, and a slow-down in the market can make selling the property at the end of the loan term something of a challenge.
This type of lending is also a lot less common now, mostly because of stricter lending restrictions imposed by banks. According to the Reserve Bank, in November 2017 $1,65 billion of new mortgage lending was done on an interest only basis, up from the October 2017 figure of $1.44 billion but dramatically down on figures from 2 years earlier (November 2015) where $2.53 billion was issued on an interest only basis.
Across the Tasman in Australia, banks are limited to just 30 per cent of new mortgage lending on an interest only basis (here in New Zealand just 19 per cent of lending in November 2017 was on an interest only basis).
Considering an interest only loan?
To help you make an informed choice, here is a quick snapshot of the benefits and risks:
- Lower repayments allow you to use your money on other investments
- A tax benefit to property investors
- A rise in property values lets you build equity in your investment
- Not paying back the principal means you owe the same amount of money at the end of your interest only loan term
- If house prices drop, you could end up in negative equity
- A rise in interest rates may make it hard for you to service your loan with limited options
Choosing the right option for you
If you are considering an interest only loan, it’s important you seek professional advice. Talk to a Mortgage Express adviser about your options as well as the benefits and risks to your property investment.
While all care has been taken in the preparation of this publication, no warranty is given as to the accuracy of the information and no responsibility is taken by Mortgage Express Limited for any errors or omissions. This publication does not constitute personalised financial advice. It may not be relevant to individual circumstances. Nothing in this publication is, or should be taken as, an offer, invitation, or recommendation to buy, sell, or retain any investment in or make any deposit with any person. You should seek professional advice before taking any action in relation to the matters dealt within this publication.
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