While principal and interest loans are still by far the most common option, interest only loans have been increasing in popularity with investors as they figure out how to use them to their advantage.
Blogger: Warren Dworcan, managing director, Rate Detective Finance
As the name suggests only the interest that is owed on the loan is payable. As a result repayments are lower than what they would be on principal and interest but they are usually only available for a small proportion of the term. Many investors find this a more flexible option as the savings can be shifted to another investment or for a different purpose. Being a short-term solution it can be highly advantageous for those looking to sell their property a few years after buying, as they aim to make a healthy profit from rental income.
The main consideration to keep in mind is that the loan amount is still due when the interest only period ends. So be aware that the repayments will rise to compensate for this. Use this time to take care of other financial obligations so you can budget accordingly.
As the principle does not get paid down, equity cannot build in the property. So you have nothing to borrow against unless the dwelling increases in value. The risk being that you end up with negative equity if property values fall below the principal owing.
However, if you find yourself with extra funds you can use them at any time to pay towards the principal. So in practice you can treat it just like a traditional loan, but you have the safety net option of smaller interest only payments if things start getting tight.
Interest only loans are becoming more popular with investors as they learn how to exploit its features. It doesn’t suit everyone’s strategy and while there can be some drawbacks later down the road it may be a solution for your portfolio.