If you’re a first-time home buyer and you’re a little daunted by the spiralling cost of a home loan, don’t worry — this is a common situation to be in. Possibly, you’ve looked at the option of an interest-only mortgage — something that will reduce your regular payments in the early stages of your mortgage, giving you the financial breathing space you need.

But is this option really a good idea? Let’s take a look at the pros and cons of this type of home loan so you can make the right decision.

The Advantages of an Interest-Only Home Loan

There are some advantages to an interest-only mortgage — this is why they have become so popular among Australia’s first-time home buyers.

Reduced Home Loan Repayments

The primary advantage of an interest-only home loan is the reduced level of your regular repayments. Because you won’t need to pay off any of the principal of the loan during this period and you are only furnishing the interest payments, each premium will be lower than it would be with a standard “principal plus interest” loan.

Potential Strategic Advantages

An interest-only mortgage could be a good option if you will be in a position to pay off the entirety of the loan further down the line. For instance, if you stand to receive a large amount of money from a business deal or an investment transaction, you may be able to use this to close the mortgage on your home. In this case, you may not feel the need to overburden yourself with greater monthly repayments that reduce the principal. Make sure that your loan provider will permit you to make this payment and close the loan before the end of the term.

Short-Term Options

You will need to pay off the principal eventually, so an interest-only loan is never going to be a permanent option. However, you may be able to take advantage of a short interest-only period, giving you some financial breathing space between paying your deposit and reducing the principal on your loan.

The Disadvantages of an Interest-Only Home Loan

Interest-only home loans are really only suitable for people in specific situations. For people simply trying to reduce their regular repayments without considering the long-term implications, there are significant disadvantages.

The Principal Isn’t Going Down

The interest-only period is exactly that — you are paying off the interest only and not the principal. The amount you owe on your home won’t be reduced, and you’ll still need to find some way to settle this principal later on.

Differing Interest Rates

Bear in mind that the interest you pay probably won’t be the same as the rate attached to a “principal plus interest” loan. You might end up paying a higher rate, which means you’ll need to pay a lot more money over the full term of the loan.

Limited Periods

As we’ve mentioned above, the interest-only period of your mortgage is temporary, typically lasting no more than five to seven years. After this, you’ll need to pay off the principal as well as the interest; if interest rates have increased by this time, you may find it difficult to manage this increase in monthly repayments.

Risk to Equity

During an interest-only period, the only way to build up equity in your property is if this property increases in value. If it does not increase in value during the interest-only period or if you need to sell your property earlier than expected, you may find that you don’t have any equity in the property when you sell.

Making Your Decision

Any option that reduces your monthly mortgage repayments is always going to be attractive, but you should proceed with caution. Think about the long-term cost of the home loan — are you prepared to make a few savings now and find yourself paying more over the full term? Despite this, a loan with an interest-only period built in can be a good option in some circumstances. If you would benefit from a period of reduced payments and are prepared to accept the increased payments further on, this option might be suitable. Just remember to weigh up your options before you make the final call.

Here at Sydney Brokers, we help home buyers from across the region in their search for the right home loan or mortgage for their needs. To find out more about your options, reach out to our team today, and let’s discuss your situation.

Disclaimer: The content of this article is general in nature and is presented for informative purposes. It is not intended to constitute tax or financial advice, whether general or personal nor is it intended to imply any recommendation or opinion about a financial product. It does not take into consideration your personal situation and may not be relevant to circumstances. Before taking any action, consider your own particular circumstances and seek professional advice. This content is protected by copyright laws and various other intellectual property laws. It is not to be modified, reproduced or republished without prior written consent.