Be Careful With “Interest Only” Homeloan/ Mortgage: a Potential Problem You Should Know

   

One of the selection when you  take a homeloan/mortgage is that you can choose to pay “Principal and Interest” or “Interest Only”. On many occassion, I do recommend to take interest only whenever possible especially if you’re an investor, because the advantage is that you will pay cheaper repayment every month, and if you’re investor that extra money (the difference) can be use for other type of investment that give you more Return of Investment. However, before you really do choose “interest only” loan, you need to understand fully a potential problem associated with this type of loan.

The Interest Only Period is Limited

This problem starts with the fact that “interest only” loan offer only limited period (for example: 3 years or 5 years) of the interest only repayment. After that period the repayment is reverted back and calculated based on principal and interest. And because of this you will have a jump (a very significant one) on your monthly repayment.

Let see the example: provided you have mortgage of $300,000.  if you pay “Principal and Interest”, with 6% interest and loan for 30 years your monthly repayment will be $1798.

Now, as comparison with “interest only” product for the same 30 years loan and 6% interest, your repayment will be only $1500 per month, A cashflow saving of around $300 per month, a quite significant amount. This is where if you’re investor, this $300 extra per month could be used for other investment purposes, for example to repay a loan of  other investment property or share/stock portfolio.

The problem is after 5 years, when the “interest only” period has elapsed, the repayment of your loan will be based on “Principal and Interest” and 25 years loan (since 5 years has elapsed) and furthermore, your principal is not a cent less. Provided the interest rate is exactly the same (6%), then the repayment will be $1933 per month.

You will find a big jump of $433 for your monthly repayment. This is normal and just a by product of this “interest only” product, so you don’t have to be alarmed, you just need to be fully aware what’s going to happen when the interest only period have expired.

You need to incorporate this to your budget. If your budget permit and you are happy to just continue the loan, then you may decide so. But if additional $433 on monthly budget put quite significant chunk on your cash flow, you need to be prepared and do something about it.

What to do

Since you know what’s going to happen, you can do the preparation and planning. What you need to do is to have your homeloan/mortgage refinanced or re-mortgaged at the end of the interest only period and extend it back to 30 years and also have another “interest only” period should you want to. This is just a bit of hassle that you need to do every 3 or 5 years (depends on your interest only period). The most important thing is you need to re-assess your situation and economy in general. Maybe at that time the interest rate is in historical low and maybe it’s more beneficial to make the loan have fixed interest rate. Or the other way around that the interest rate is so high and maybe more profitable to sell the property. In short, don’t do just extend or refinance your loan without really asses the situation.

Now, you may want to calculate the real number that you have here: mortgage repayment calculator.

Happy Planning !

Be Sociable, Share!

• 

Related Posts

• Taking a mortgage ? Do Not Change Your Lifestyle Dramatically
• Offset Account: A Must Have For Your Mortgage
• Getting Your First Home Loan or Mortgage: Not That Hard!
• Why You Should Always Use Mortgage Broker For Your Homeloan
• Mortgage: Change To Fixed Rate or Keep It Variable ?

Denis Kristanda  

Leave a comment