Interest only loans

Interest Only Versus Principal And Interest

Interest only loans refer to the way you want to repay your loan to the bank. Your choice of repayment type (interest only versus principle and interest) is a separate choice to your choice of interest rate type (fixed or variable)

Repayment Options

Interest only is where you ask a lender to allow you to only repay the interest cost each month (where interest is the cost the lender charges you for the privilege of borrowing their money). In this case the lender doesn’t force you to pay any additional principal amount over and above the interest cost. If you have chosen a variable rate loan (as opposed to a fixed rate loan), you still have full flexibility to pay any additional principal amount you want each month. With interest only repayments on a variable rate loan, you are not forced to pay extra each month over and above the interest only repayment … but you still can pay extra if you want to and are able to.

Principal and interest is where you agree with the lender upfront to pay not only the interest cost, but also an additional amount of principal each month. Principal and interest repayments are commonly calculated at a level of repayment where the loan amount in question would be paid down to zero if this repayment level was adhered to over 30 years … all else remaining the same (ie no change in interest rate during the repayment term)

If you select a loan with an 100% offset account facility any funds put into (or are left in) this account is equivalent to automatically paying additional principal off your loan. For example, $1,000 placed in your 100% offset account has the same effect on your loan balance as if you took the same $1,000 and paid it into your loan to reduce the loan balance by $1,000. Therefore, a variable rate loan on interest only repayments with a 100% offset account can be an equivalent substitute for a principal and interest loan if interest rates were the same.

Interest Only Interest Rate Levels

Up to around 2016 virtually all lenders charged the same interest rate for interest only repayments and principal and interest repayments. Since that time however, interest only loans are usually on a higher interest rate compared to principle and interest loans.