Interest Only vs Principal & Interest [Home Loans]

Home loan repayment options can seem complex, but choosing the right one is crucial to your financial future. In this comprehensive video, we delve into the heart of the matter - Principal and Interest versus Interest-Only repayments.
We'll shed light on the fundamental differences between these two strategies, how they affect your debt, homeownership, cash flow, borrowing power and tax benefits. We also discuss the various scenarios where each type of repayment can be beneficial, while also pointing out potential pitfalls to watch out for.
Whether you're a first-time homebuyer or an experienced property investor, this video is set to provide you with the knowledge you need to make an informed decision.
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[@michaelstk2817]

Good information 👍

[@MortgageBrokerAustralia]

Thank you!

[@britts6847]

Thank you for this summary! I am considering a HELOC and am trying to choose between the interest only option and the interest and principle option. All other things being the same, which one saves you more money over the life of the loan? Particularly in the draw period. Does paying the interest every month save you money in overall interest being paid? For example, If I have a $100,000 HELOC and pay interest only for the draw period vs pay both principle and interest over the same amount of time, do I pay more or less interest?

[@MortgageBrokerAustralia]

Hi Britts, thanks for your question. When it comes to a Home Equity Line of Credit (HELOC), the main difference between the interest-only option and the principal and interest option is how the payments are structured. Let's break it down: Interest Only Option: During the draw period, you only pay the interest that accumulates on the amount you borrow. No reduction of the principal balance takes place. At the end of the draw period, you would still owe the full $100,000 you borrowed, because none of the principal has been paid down. Principal and Interest Option: In this case, every month you pay not only the interest that accumulates but also a part of the principal amount you borrowed. By the end of the draw period, you'll owe less than $100,000 because you've been chipping away at the principal with each payment. Now, to the core of your question: Which saves more money in terms of interest? If all other factors are the same (like interest rate and duration of the draw period), paying both principal and interest during the draw period will save you more money in the long run. This is because as you pay down the principal, there’s less loan balance for interest to accrue on. So, over time, the amount of interest you’re charged each month decreases. On the other hand, with the interest-only option, you're essentially keeping the loan balance the same throughout the draw period, which means the interest amount you pay each month remains consistent and doesn’t decrease. In summary, if you can manage the slightly higher monthly payments of principal and interest, it's generally more cost-effective in terms of overall interest paid. But, it's also essential to consider your financial situation and what monthly payment structure fits best with your budget. I hope this clarifies things for you!

[@britts6847]

@@MortgageBrokerAustralia Thank you so much for a quick response! Let me give a few more details. I have a 20 year draw, 20 year pay loan I am applying for. I definitely intend to be done with the LOC before the repayment phase begins (completely paid off). Even if I do the interest only option, I plan to mostly make payments over the minimum to make sure the principle is going down during that time, but in hard times I would like the option to pay less (just interest is a lower payment vs 1% of the balance). I also would want my credit report to reflect a lower minimum payment. I have two drawbacks. 1) the interest only option has a slightly higher interest rate 9.5% vs 8.5% with the other option. 2) I cannot figure out which option costs me more money in interest....can you help me decide please?

[@MortgageBrokerAustralia]

Of course! Let's dive deeper into your situation. Flexibility: Choosing the interest-only option provides more flexibility during the draw period. If times get tough, you can pay just the interest and not the principal, resulting in a lower monthly payment. On the positive side, even though it's an interest-only option, you can still make payments towards the principal whenever you like, reducing the balance. Interest Rate Difference: As you mentioned, there's a 1% interest rate difference between the two options. Over time, especially on a large balance, this can make a noticeable difference in the amount of interest you pay. Let's break down the interest cost using some simple math: Interest Only Option (9.5% rate) on $100,000: For the first year (without any principal reduction): $100,000 * 9.5% = $9,500 Principal and Interest Option (8.5% rate) on $100,000: For the first year (without considering principal reduction, for a direct comparison): $100,000 * 8.5% = $8,500 That's a $1,000 difference in interest for just the first year. Over several years, this difference compounds, especially if the principal isn't being paid down rapidly. Credit Report Implications: Opting for the interest-only option will reflect a lower minimum payment on your credit report, which might be beneficial depending on your future financial plans and decisions. Considering these factors, here are some things to ponder: If you feel confident in your ability to pay more than the minimum most of the time, and if you value the flexibility of having a lower minimum payment available, the interest-only option might suit you. However, do remember that it comes with the trade-off of the higher interest rate. Over the long haul, the principal and interest option at 8.5% will save you money in terms of interest, especially if you can maintain the payments. It's a more structured approach, ensuring you're consistently paying down the principal, but with less flexibility in monthly payments. In making your decision, it might help to think about your financial outlook and confidence over the next 20 years, your appetite for flexibility vs. structure, and the importance of the differences in interest costs and credit report implications to your overall financial strategy. If you're still uncertain, we'd recommend having a chat with a financial advisor or planner who can provide a more tailored analysis based on your full financial picture. And of course, we at Hunter Galloway are always here to help guide you on your home-related financial journey!

[@britts6847]

@@MortgageBrokerAustralia I really appreciate your quick responses and detailed explanations to help me! After weighing the factors, I decided the best option would be the lowest interest option, which was the 1% payment option. Lets see how it goes! Thank you so much!!

[@susmusmanoj112]

U mentioned that we cannot pay into the loan when it's IO. Oes that mean that we can't pay off into the loan when IO for 5 years ? 😥😥😥😥😥😥 Is this for some banks or all banks

[@MortgageBrokerAustralia]

Most banks allow borrowers to make additional payments towards the principal, even if it's an interest-only loan. By doing so, you can reduce the overall balance and potentially pay off the loan faster. However, it's important to check with your specific bank or lender to confirm their policy regarding extra payments on IO loans. Different banks may have different rules or restrictions, so it's always best to reach out to them directly to get accurate information. Remember, it's essential to fully understand the terms and conditions of any loan you're considering, and discussing your options with the bank or lender can provide you with the clarity you need.