Property investors love interest-only loans, but most never stop to think about what happens when the interest-only period comes to end.
As you probably know, with an interest-only loan your repayments are lower than with an equivalent principal and interest loan, as you only pay the interest component and the fees.
In other words, while you’re only paying interest, you aren’t paying off any portion of the loan.
That’s why these loans are popular with property investors, as it allows them to put more cash into paying down non-deductible debt or into other assets.
Critically, interest-only loans generally allow you to ‘pay the minimum’ for a period of between five and 10 years.
When this period expires, the loans automatically switch to a principal and interest loan with a corresponding increase in repayments.
The jump in repayments can catch many investors off-guard, particularly as repayments are calculated based on the remaining term of the loan.
For instance, if you took out a 30-year loan and paid only interest for the first 10 years, the repayments (once the loan switched) would be based on paying back the loan in just 20 years.
It’s worth noting that the adjusted repayments would be higher than if you had started paying principal and interest at the start of the loan.
What are your options when your lender notifies you that your interest-only period is expiring?
Firstly, you can do nothing and simply start paying off the loan.
But if you don’t want to do this, you could ask your lender to extend the period.
Some lenders will do this quickly and easily, others will require some sort of credit assessment or loan switching, and some just won’t do it at all.
When the market is competitive and lenders are hungry for business, you’ll find that most will try to keep their customers happy.
Another option is to refinance the loan with another lender, which, as well as providing a new interest-only period, could save you money.
As always it’s best to talk with your trusted broker before doing anything.
They will be able to advise you accordingly.