Over the last 12 months, the demand for interest-only loans has dropped by 20 per cent. This is partly because interest-only loans now have much higher rates and also because the banks aren’t giving out interest-only loans unless you can justify it.
Amongst the Big Four lenders an interest-only (i/o) loan is at least 0.5 per cent more expensive than its principal and interest (P&I) counterpart. While in the short-term, an interest-only loan might help your cashflow, it could come back to bite you on the bum later.
If we take a current example using CBA’s published rates* of 5.17 per cent interest-only or 4.67 per cent principal and interest for a $500,000 loan, then the differences are marked.
Sure, in the initial months the i/o loan is more affordable with repayments of $2,154 versus $2,584. But, over the lifetime of the loan the interest-only borrower is worse off. In fact, over a 30-year loan, the borrower pays $61,653 more.
Not only does the i/o borrower face higher interest rates, at some point they have to pay back the principal of the loan and at the higher rate.
Most interest-only periods are for five years; after that borrowers have to start paying principal too.
To make things harder, the borrower has to repay 30 years’ worth of principal over a 25-year period!
The Australian Prudential Regulation Authority (APRA) has given the banks a target of only 30 per cent for new loans being interest-only. But it looks like the banks have slammed the breaks on much harder than APRA would require – the industry reckons new interest-only loans are only about 12 per cent of total new mortgages.
This does not mean that the banks won’t give interest-only loans – just that you have to prove you need it that way.
Many financial advisers recommend interest-only loans for investment properties if there is a P&I loan on an owner-occupied property.
If you would like to discuss your lending situation with me – particularly on what a P&I or i/o loan means for you, please feel free to contact me on 1300 30 67 67.
*of course I am negotiating better rates than this for my clients (I recently got 3.59 per cent). But the spread is still the same