Interest Only Vs Principal and interest
What’s the difference between an interest only loan and a principal and interest? And which one do you need?
An interest only loan can be offered to people who are not worried about paying their loan off.
An interest only loan can be offered to people who are not worried about paying their loan off. For example, an investor looking to secure an investment property may be more interested in capital growth of the property and prioritising cashflow for other investments or lifestyle rather than paying down the loan. It is a loan in which the bank only requires the interest to be paid off each month, without any of the principal loan amount. Most interest only loans revert to principal and interest after 5 years, at which time you could apply for a new term of interest only.
One of the advantages of an interest only loan means that investors can make lower repayments during the first few years of a loan, making it more possible for them to take on the new investment. After the first five years, often they can ask slightly higher rent, or they may be in a stronger financial position and able to service the increased amount of the loan.
The drawback to an interest only loan is that the principal amount doesn’t get any lower. Each month the bank receives their payment for the interest of the loan but the loan amount doesn’t reduce. Over the life of the loan, an interest only loan will mean a greater amount of money goes to the bank. This can often be tens of thousands of dollars, so it is important to understand what this will look like prior to signing for it.
Principal and interest loans are structured so that each month the interest of the loan is repaid to the bank, along with some of the principal amount. Although the monthly repayment will be greater, over the life of the loan the total amount will be less and the loan will be repaid faster.