Can I switch to an interest only home loan to reduce my repayments?

With interest rates rising throughout 2022 quite substantially, and lots of people are understandably looking for ways to save money. From negotiating with power companies through to cutting off streaming services there are lots of ways to reduce outgoings. On the home loan front, options for many including refinancing to another lender to utilise some great cash back offers going around, negotiating a better rate with their existing lender or swapping to interest only repayments.There are some things to think about when it comes to swapping to interest only that you need to consider before you do it.

Interest only home loan rates are higher

Several years ago, APRA clamped down on interest only lending across Australia requiring banks and lenders to have less interest only loans on their books. The net result is less people are approved for interest only loans (especially owner-occupied loans) and interest rates on these products are higher.

You’ll need to undergo full credit assessment to switch to an interest only loan

This can be a bit of a deal breaker for some people. If you’ve recently been assessed, you may not want to have to go through the full credit assessment process again as supplying documentation can be onerous.

However, for some people being fully reassessed may not be viable right now. Why? Because when the lender assesses repayments, they take their current rate and add 3%. For lots of lenders this means they’ll be assessing your ability to make repayments at around the 8% mark which is much higher than what they were assessing at just 12 months ago when we had fixed and variable rates sitting below 2%.

Your interest only period will expire and repayments will revert to principal and interest

You can select an interest only period, this may be up to five years depending on the loan type and the lender. Once this period expires you will revert to principal and interest and be required to start paying off the principal loan.

Of course, this means your repayments go up. But it’s important to note they will be higher than if you’d opted for principal and interest from the start. The reason being you still have to pay off the same amount, but you now have less time to do it in as you used the first couple of years to only pay interest.

You will be paying more interest over the life of the loan

Whilst you will have lower repayments during the initial interest only period, because you aren’t paying off any of the loan balance you end up paying more interest over the life of the loan.

Here’s an example provided by NAB:

The gap in repayments reduces as rates go up

The more interesting thing is that as home loan interest rates increase, the monthly repayment gap decreases.  And as you pay more for interest only on an owner-occupied property, it becomes almost the same if rates were to get to 7%. The below rates are for an owner-occupied property.

NOTE: These rates are indicative only and don’t constitute an offer of credit, or a guarantee of what you situation or repayments may look like. You need to speak to your credit advisor and have your own situation assessed before deciding. Investment loan interest only rates are lower than owner occupier interest only rates.

Interested in chatting with someone about interest only home loan options?

Get in touch