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[MoreMore Insights] Principal & Interest VS Interest Only

Australian bank loans have two ways of loan repayment, one is the principal and interest, the other is interest only. Many home buyers are hesitant between the two when it comes to loans - then the following information should not be missed.



Principal & Interest


Principal and interest means that borrowers repay the principal balance and accrued interest for their loan. Assuming that the loan interest rate remains unchanged, borrowers choose this way to reduce the principal balance of the loan, further reduce the interest included in the next monthly payment. Therefore, loan’s principal and interest are constantly decreasing throughout the repayment period.


Pros


-The total interest required is less over the repayment period;


-Compared with the way of interest only, its interest rate is relatively low;


-Shorten the overall repayment time and pay off the loan as soon as possible.


Cons


-Its monthly payments are higher than interest only, and multiple mortgages will reduce cash flow;


-The more needed for repayment funds, the less investment opportunities.



Interest Only


Interest only repayment refers to borrowers only repaying the interest generated by the loan within the selected term, and not repaying the principal. The interest only term is normally 1-5 years, but some banks could do up to 10 years. After the interest only term expires, the loan will automatically convert to the principal and interest. As for borrowers who want to continue interest only repayments, they can refinance and choose a new interest only term, and the overall loan term will be updated to 30 years.


Pros


-The repayment amount within the term is relatively low, so it increases the borrowers’ cash flow. The investment cost is lower, and the extra money can be used for other investments;


-With offset accounts, it can reduce interest costs and monthly payments.


Cons


-Its interest rates are generally higher, and since the principal amount remains the same, the total interest paid over the life of the loan will be more;


-The borrowing power calculation for interest only will be worse than standard principal & interest repayment;


-For owner occupied home loans, most lenders won't approve interest only repayments.


Summary


Owner occupied home loan can choose principal and interest repayements, which can repay the loan faster and reduce the total interest paid. While investment home loan may consider interest only repayments, in order to increase cash flow and make use of tax advantage. The specific situation should be based on borrowers' own financial situation and loan objectives, and will recommend you to get the advice from professionals.

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