January 31, 2020
Willie Gunn
All Blogs

Explained: The Curious Case of Interest-Only

Here’s a 101 guide for understanding interest-only loans and for spotting the trip wires lurking in the weeds.

There is a quote attributed to the American inventor Charles F. Kettering: “My interest is in the future, because I am going to spend the rest of my life there.”


For some of you out there, depending on your age, mortgage loan term, and retirement strategy, “interest” may well be something that you will spend the rest of your life with!


With that enjoyable preamble out the way, let’s move on to today’s curious case: Interest Only (I/O).


With most investment property lending (and, in rare cases, owner-occupied lending) there will be a period of I/O repayments that may be offered by the bank (up to a 5-year period). This is exactly what it sounds like: you pay no principal off your mortgage; you only pay interest.


This is a common strategy, and frees up some extra cash that can be put towards another part of your retirement strategy, such as paying down your owner-occupied mortgage, purchasing another investment property, or purchasing new toys like Lance’s new noise-cancelling headphones (not really part of a retirement strategy, but they are awesome!).


While it makes sense to avail ourselves of the wonderful product that is interest-only, we do feel the need to remind you to think of the future! But, what actually happens when your I/O period expires?


Well, the easy answer is that it reverts to principal and interest repayments. However, all is not as it seems. We must not forget that if our original loan term was 30-years, we will now be paying the principal off at a 25-year loan term.


Here’s an example:


Assuming a 30-year loan of $500,000 at 4.00%, monthly I/O repayments would be $1,667. After a 5-yr period of Interest Only repayments, this would jump to monthly principal and interest repayments of $2,639.


If you do have an I/O period that is coming up for expiry, there are four main options available:

1.     Accept the increase in repayments,

2.     Sell your property,

3.     Move banks, or

4.     Request an extension of your Interest Only period.


In our humble opinion, the latter is the easiest of all four options.

If we have piqued your curiosity with our latest case, and you’d like to know more, please don’t hesitate to get in touch with your Advisor. They await your responses with interest!      

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