The difference between interest-only home loans and principal loans
Nobody starts out understanding every property term there is, and there’s no doubt that it can be tricky when you first set foot on the property ladder.
For example, there is a variety of home loan and mortgage types, and finding the right one for you can make a huge difference in your repayment plans. Take a look at the difference between interest-only home loans and principal loans to help decide which one might be best suited for you.
Principal loans 101
A principal loan – otherwise known as a principal and interest loan – is your stock standard kind of mortgage.
Basically, if you buy a home for $400,000, that purchase price is your principal. Most people will need to borrow most of that money from a bank or other lending institution in order to make the payment, and in order for banks to be able to survive and continue offering loans, they will charge interest on that loan.
When you have a principal and interest loan, it means that whenever you make a payment to your mortgage, you’re paying off both the principal loan and the interest at the same time.
There are a range of principal mortgage options, such as fixed interest rate home loans and standard variable home loans. Each of these options offer their own features, but they all ensure that you’re paying off both the original principal and the annual interest at the same time in order to slowly pay off the entire mortgage.
Interest-only loans 101
When you opt for an interest only loan, you’re agreeing to only paying off the interest that accrues each year. This essentially means that for as long as you’ve got an interest-only loan, your principal will never actually drop below where it started.
The main benefit of these types of loans is that your payments will be lower. For example, you might only pay $400 per week on an interest-only loan, whereas a normal loan might require closer to $600 per week in repayments. However, interest-only loans will generally only last for a certain time period, usually five years, before reverting to a normal loan.
It’s important to note that once the interest-only period has finished, you’ll still pay the normal interest rate on the principal, which can mean you end up paying a lot more interest than if you’d started off with a principal-and-interest loan in the first place.
Therefore, interest-only loans tend to work best for property investors or people who need to keep their initial repayments at a minimum for a short period of time, such as when you are planning to buy and sell property in a small time frame.