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Top 10 Benefits of Interest-Only Loans for Home Buyers & Investors in Melbourne

The ins and outs of interest only loans for home buyers and investors in Melbourne

Have you been wondering about interest only loans and if they might be a good fit for your financial journey? Let's explore what they are all about and uncover the top benefits they can offer both home buyers and investors in Melbourne.

What is an interest only loan and how does it work?

An interest only loan is a type of home loan where, for a set time (usually one to five years), your repayments cover just the interest on the amount you have borrowed. During this period, you are not reducing the original loan amount, also known as the principal.

This kind of loan can be quite appealing if you are looking for lower monthly repayments in the short term, especially if you are an investor or a home buyer with other financial commitments. It offers a lot of flexibility for managing your cash flow, which is great if you expect your income to grow in the future.

How does it work?

With a standard home loan, your repayments are split between paying off the interest and gradually bringing down the principal. But with an interest only loan, you are only responsible for the interest during that initial period. This means your monthly repayments are lower compared to a principal and interest loan.

It is important to remember that once the interest only period ends, your repayments will increase to cover both the interest and the loan principal. Thinking ahead and making sure your future financial situation can comfortably handle those higher repayments is key.

An example of an interest only loan

Let's imagine you take out an interest only loan for $500,000 at a 5% interest rate, with a five year interest only period.

During the interest only period, your monthly repayment would be around $2,083 (calculated as $500,000 x 5% ÷ 12).

After the interest only period ends, if your remaining loan term is 25 years, your repayments would increase significantly because you now need to pay off both the principal and the interest. Your new monthly repayments could be around $3,252 (assuming the same interest rate).

This example really shows how an interest only loan can offer you some breathing room with your monthly payments in the short term. It just means you will need to plan for those larger repayments when the interest only period finishes up.

How ideal is the Melbourne property market 2024 for interest only home loans?

The Melbourne property market in 2024 is looking really positive for those considering interest only loans, especially for investors. Property values are growing steadily, with the median house price sitting around $915,000 according to CoreLogic. This points to strong potential for capital growth.

For investors, this can mean you can hold onto properties and benefit from rising values, all while enjoying lower monthly repayments during that initial interest only period.

Melbourne's rental vacancy rate is also quite low at 1.4% according to Domain. This indicates strong rental demand, which is excellent for investors looking to maximise their rental income. With interest rates averaging around 5.2% in 2024, there are still competitive deals out there, and a mortgage broker can certainly help you find them.

10 benefits of interest only loans

Now that we have covered the basics of interest only loans and had a look at the Melbourne property market in 2024, let's explore some of the key benefits of choosing an interest only loan. These can be helpful whether you are a home buyer or a seasoned investor.

  1. Lower monthly repayments during the interest only period. One of the biggest drawcards of an interest only loan is that your monthly repayments are lower during that initial interest only period. Unlike principal and interest loans, where you are paying down both parts, interest only payments just cover the interest for a specific time, usually between one to five years. This means your monthly payments are noticeably lower.
  2. Improved cash flow management. Lower repayments mean your cash flow can be much easier to manage, especially for property investors. When you are only paying interest on the loan, you can use those extra funds to cover things like maintenance costs, unexpected expenses, or even invest in other areas. This can be really helpful if your rental income does not immediately cover all your mortgage and other costs. Interest only loans give you the flexibility to keep more cash on hand. For investors, this could mean having enough money for emergencies or other investment opportunities without the pressure of higher mortgage payments.
  3. Maximising tax benefits for property investors. In Australia, property investors might be able to claim tax deductions on the interest payments for their investment properties. With an interest only loan, you are generally paying more interest during the interest only period, which could increase your potential tax benefits. Just remember, tax rules can be a bit complex, so getting independent tax advice is always a good idea. Being able to claim tax deductions on interest payments can be a real advantage, especially if you plan to hold onto the property for a long time, as it can improve the overall profitability of your investment.
  4. Greater flexibility for investors. Investors often use interest only loans as part of their investment strategy, particularly in the early years when rental income might be lower or the property value is expected to go up. The lower initial repayments can help you navigate any financial bumps, like vacancies or unexpected repairs. Plus, it gives you extra cash for property improvements or other investments.
  5. Ability to make extra repayments. Many interest only loans actually let you make additional repayments towards the principal even during the interest only period. This can give you the best of both worlds: lower monthly repayments, plus the flexibility to reduce your outstanding loan balance when you have extra cash. Just be sure to check your specific loan terms, as some lenders might have restrictions or break costs for early repayments.
  6. Opportunity to build capital growth. An interest only loan can help you invest in property while keeping your monthly repayments lower. This allows you to hold onto the property longer and potentially benefit from capital growth. Melbourne’s property market has shown solid capital growth over the years. According to REIV, Melbourne house prices have historically grown by 5-7% annually, though market conditions can always vary. By choosing interest only payments, you can focus on holding your property for a longer period, hoping to sell when the value appreciates, all while keeping your costs manageable.
  7. Short term relief for home buyers. Interest only loans are not just for investors. If you are a first time home buyer in Melbourne, these loans can be beneficial too. Let's say you are expecting your income to increase soon, or you have some big upcoming expenses like renovations or starting a family. In these situations, the lower repayments during the initial interest only period can offer some welcome financial breathing room.
  8. Flexibility to switch to principal and interest loans. Many interest only loans come with the option to switch to principal and interest repayments after the interest only period ends. This means you have the flexibility to adjust your repayment strategy as your financial circumstances change. Just remember that your repayments will increase once you start paying off the loan principal.
  9. Potential for competitive rates in some cases. While interest only loans can sometimes have slightly higher interest rates than principal and interest loans, there are situations where lenders offer very competitive interest only rates. This is often the case for borrowers with strong credit scores and solid financials. It is always a good idea to compare loan rates and shop around to find the best deal. This could potentially save you a lot of money over the life of the loan.
  10. More control over your investment strategy. With the ability to manage cash flow, make the most of potential tax benefits, and take advantage of capital growth, interest only loans can give property investors more control over their investment strategy. Whether you are holding a property for the long term or planning to sell once the value increases, this type of mortgage offers the flexibility you need for Melbourne’s ever changing property market.

Case study: how an interest only loan helped a Melbourne investor

Let’s look at Sarah, a property investor from Melbourne who bought a $900,000 investment property in 2022. She chose a five year interest only loan, with her monthly repayments sitting at $3,000. This gave Sarah the flexibility she needed to cover her mortgage repayments while waiting for her rental income to grow and the property’s value to go up.

After five years, her property's value had risen to $1.1 million. By the time her interest only period ended, Sarah was able to switch to a principal and interest loan with higher repayments. However, because of her capital growth and increased rental income, Sarah was in a much stronger financial position to comfortably handle the higher repayments.

Things to keep in mind with interest only loans

While interest only loans offer those lower initial repayments and great flexibility, there are a few important things to think about.

  • Higher repayments after the interest only period: Once that interest only period ends, your repayments will increase as you start paying both the interest and the principal. It is really important to make sure your finances can handle this jump.
  • No principal reduction: During the interest only phase, your loan balance does not go down. This means you are not building equity unless the property value increases. This could be a bit risky if property prices happen to drop, potentially leading to negative equity.
  • Long term costs: You will likely pay more in interest over the life of the loan because the principal remains untouched during the interest only period. This can make interest only loans a bit more costly in the long run.
  • Stricter lending criteria: Lenders often look for stronger financials when it comes to interest only loans, which can include higher deposits and tighter credit criteria. This might make them a bit harder to qualify for.
  • Refinancing uncertainty: Refinancing after the interest only period is not always guaranteed. If property values fall or your financial situation changes, refinancing could become a bit more difficult.

It is always a good idea to chat with a mortgage broker and seek tax advice to weigh up these aspects and see if an interest only loan really aligns with your goals and circumstances.

FAQs

How long can I have an interest only loan?

Most lenders offer interest only periods between one to five years. After that, your repayments will switch to principal and interest.

Can I make extra repayments during the interest only period?

Yes, many interest only loans do allow extra repayments, but it is always best to check your specific loan terms for any restrictions.

Are interest only loans good for first time home buyers?

They can be helpful if you need lower initial repayments. Just be aware that repayments will increase once the interest only period comes to an end.

Are there tax benefits with an interest only loan?

For property investors, the interest on your loan might be tax deductible. However, it is really important to seek independent tax advice to understand your specific situation.

What happens when the interest only period ends?

Your repayments will switch to principal and interest, meaning your monthly repayments will increase.

Are interest only loans riskier than principal and interest loans?

They can carry a bit more risk because your loan balance does not decrease during the interest only period. However, they offer a lot of flexibility depending on your financial strategy.

Final thoughts

Interest only loans can be a clever choice for both home buyers and investors who are looking to manage their cash flow, make the most of potential tax benefits, or invest in Melbourne’s property market.

However, just like any financial decision, it is important to think about the benefits alongside any potential considerations to make sure it aligns with your long term plans. With the right advice, you can make a really informed choice that suits your unique circumstances.

If you are thinking about an interest only loan, please reach out to a trusted mortgage broker. They can guide you through the options and help you find the best solution for your situation. Ready to take the next step? Contact LM Connect at 0423 713 362 for personalised mortgage advice tailored to your needs.


Published: 23/6/2025
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