Interest Only Loans – Why ?

I will start this post with the disclaimer that none of this article is financial advice and does not take into account your personal circumstances, please see a qualified financial planner for your needs 🙂

For some time now the term ‘interest only’ has been associated with many business loans and investment loans and in some rarer occasions your principle place of residence too. Madness !

The question for a lot of people, especially those that have never utilised interest only payments before is Why ?

The best reasoning I can give you behind this is the following: You are only contractually obligated to make interest repayments on your loan to your lender. That means every month you only repay the interest due on the loan, the loan does not reduce at all and if you stay on interest only for 5 years, after the 5 years your loan balance has not changed. If you are on a variable rate loan, you can still make your own ‘Principal Payments’ without any penalty and build equity into your business or investment sooner. But, if there comes a time when you need access to additional cash flow, you know you are only contractually obligated to make that lower interest only payment. This relies on you fully understanding your own personal goals and how long it will take you to get there.  There are plenty of other reasons too of course, taxation benefits, negative gearing, cash flow movements, using lower repayments to pay off more expensive debts. The biggest concern with interest only repayments is falling into the trap of thinking you have more disposable income than you actually do !

Spending that extra income on non essential luxuries or non income producing assets is not what you should be using interest only for. The new jet-ski looks great on the water and the holiday you took to Europe was amazing, but you haven’t paid down any debt and not helped build any equity into your asset. So yes your monthly payments are lower, but quite likely your interest rate will be higher and you will also pay more interest in total over the period of the loan. For me interest only has its absolute benefits and if you use it correctly can be a great tool to actively manage your cash-flow in any business or investment.

PROS:

• lower mortgage repayments
• potential tax benefits

CONS:

• not building equity into your business or asset
• higher repayments once interest only finishes
• loan balance stays the same

So choosing an interest only facility over a ‘principal and interest’ P&I facility can definitely have it’s benefits as long as you use it for the intended purpose and not spend that additional monthly cash wastefully.

Interest Only vs Principal and Interest Loans Repayments and Interest

Here is an example of both an interest only loan and a principal and interest loan and the difference in interest paid but also the monthly payment difference too.