Interest Only Loan
A loan where the borrower pays only the interest charge for a set period, leaving the principal balance unchanged.
In detail
Interest only loans let borrowers reduce their minimum repayment during a defined period, usually one to five years. At the end of the period the loan reverts to principal and interest repayments over the remaining term, which means the P&I repayment after the IO period is higher than it would have been on a straight P&I loan.
APRA tightened interest only lending in 2017 and while some of those restrictions have eased, lenders still cap IO lending at 80 per cent LVR on most products. Investors use IO to maximise cash flow and deductible interest while directing surplus funds to non deductible owner occupier debt. Owner occupiers rarely benefit from IO outside of specific short term situations.
Why it matters for brokers
IO loans carry rate loadings and have a payment shock at reversion. Brokers need to model both the IO period and the post reversion P&I repayment when presenting options to investor clients.
Example in practice
A property investor has an $800,000 loan with a five year IO period at 6.4 per cent. The IO repayment is around $4,267 a month. When it reverts to P&I over the remaining 25 years, the repayment jumps to around $5,407 a month, a $1,140 monthly increase the investor must be prepared for.
Related terms
Principal and Interest (P&I)
A loan repayment structure where each instalment reduces both the loan balance and the accrued interest.
Rental Income
Income earned from leasing out an investment property to a tenant, usually collected monthly or fortnightly.
Variable Rate Loan
A home loan where the interest rate moves up or down over time in response to market conditions and lender pricing decisions.
Serviceability
A lender assessment of whether a borrower can meet loan repayments from their income after accounting for expenses, existing debts, and a buffer.
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