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Principal and interest vs interest only loans

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Principal and interest vs interest only loans

If you’re hunting for a home, then it might be time to find the right loan. Here, we look at the differences between principal and interest and interest only home loans.

What’s the difference between principal and interest?

A home loan is split into two parts: principal and interest. Need a refresh on what they mean?

  • Principal is the amount of cash you borrow to buy your home sweet home.
  • Interest is the amount you pay for borrowing the principal.

Two types of home loans

Now we know what principal and interest are, here are two ways you could pay back a loan:

  1. A principal and interest (P&I) loan is where you start paying back both the amount you borrowed and interest from day dot.
  2. An interest only (IO) loan is where you pay back just the interest for a set term unless you make extra repayments (more on that later!). Once the term is up, you’ll ride out the rest of your mortgage paying off both the principal and interest.

With UBank, you can have an interest only loan for up to five years if you’re calling the place home. But if it’s an investment property, it could last a decade.

What are the pros of a principal and interest loan?

  • You could be chipping away at your loan quicker.
  • You might be able to redraw surplus funds if you’re ahead of your minimum repayments and your loan is on a variable rate.
  • The rates might be lower meaning you’ll pay less interest. See what your lender is offering, or check out our competitive rates here.

What about the cons?

  • Your loan repayments will be higher than what you’d pay during an interest only period.
  • For those with an investment property, you might have less cash to play with or fewer tax benefits.

What are the pros of an interest only loan?

  • You could enjoy a dip in your repayments during the interest only period.
  • There might be some tax benefits for investment properties.
  • You’ve got the option to pay off some of your principal during the interest only period if you have the cash.

And the cons?

  • You might pay more interest overall because your rate could be higher.
  • Your principal won’t go down during the interest only period unless you make extra repayments.
  • Once your interest only period wraps up, your repayments will likely increase.

Example

Lucy’s found her dream home but isn’t sure whether to lock in a principal and interest or interest only loan. She makes enough to cover the principal and interest repayments but also wants to have some cash left over for a holiday and new car. The table below shows how things could change for Lucy depending on which repayment type she chooses.

Principal and interest loan

Interest only loan (5-year term)

Interest rate

2.34% p.a.*

2.88% p.a.*

Property price

$750,000

$750,000

Loan amount

$600,000

$600,000

Loan term

30 years

30 years

Monthly repayments (years 1-5)

$2,321

$1,440

Monthly repayments (years 6-30)

$2,321

$2,644

Amount of interest charged over the 30 year loan period

$235,602^

$279,483^

*These are example interest rates that could change. You can check out our latest rates here.

^This example assumes Lucy has not made any additional repayments over the life of the loan. It also assumes that the interest rate is unchanged for the term of the loan. In practice, variable rate interest rates can change over the life of a loan which will alter the comparison.


Pro tip: If you’re tossing up between a principal and interest or interest only loan, get a glimpse at what your repayments could be with our handy
calculator.


At the end of the day, it’s important to pick the right loan for you. Looking at the pros and cons has hopefully helped make the decision a bit easier. What’s next? Maybe it’s time to choose between a fixed and variable loan… or enjoy the best of both worlds with a split loan.


You can also check out our epic home loan rates.


Found your dream home, or a cracking deal on an investment property? Kickstart your application today by clicking here.

 

UBank is a division of National Australia Bank Limited ABN 12 004 044 937 AFSL and Australian Credit Licence 230686. Credit is provided by AFSH Nominees Pty Ltd ABN 51 143 937 437 Australian Credit Licence 391192. UBank is the mortgage manager for UHomeLoan products.

Terms and conditions, fees and charges, credit criteria apply to all UBank’s home loan products and are available on application.

The information contained in this article is of a general nature only. It doesn’t take account of any person’s objectives, financial situation or needs. Before acting on this information, you should consider whether it is appropriate for your circumstances and seek independent legal, financial, and taxation advice.