What do I need to know about interest-only loans?

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Finding the right kind of loan takes time. We've discussed before how the most suitable loan isn't always purely about the interest rate, but you'll still see a number of people prick up their ears at the idea of a mortgage that reduces your repayments for the first few years. In fact, it's proving to be a devilishly tempting option for many New Zealanders these days.

Yes, it's true: interest-only loans are starting to become a serious consideration for first home buyers and investors alike. In fact, the Reserve Bank of New Zealand has revealed that the value of new interest-only lending per month has almost doubled since the start of the year.

With so many people choosing to go interest-only, you might be asking yourself why it's proving so popular. Here's what you need to know about this method of financing: both the pros, and the cons.

The reward

Interest-only loans are particularly popular among investors - though that isn't to say that first- or next-home buyers don't utilise them as well. Because you are only paying off the interest on the loan, your monthly repayments are lower than they would be with a regular principal-and-interest mortgage.

This can be a good strategy for some people, particularly those investing in Auckland. The higher values in the City of Sails mean a larger mortgage and larger repayments: reducing these makes the mortgage more viable. Meanwhile, the property itself takes advantage of the recent strong gains reported across the city by QV.

With the right purchase, your real estate may grow in value enough to offset the higher repayments once the grace period times out.

The risk

Without the right advice, it can be a dangerous gambit. Interest-only loans should be considered as a single tool among many - it is not a silver bullet for affordability issues. Furthermore, you have to remember that while interest-only loans are available to a lot of people, you do still have to fulfil certain criteria: You have to have 20 to 30 per cent equity in your current loan (so a 20 per cent deposit at a minimum for a new purchase).However, it is these higher repayments that could end up being a stone in the shoe of an interest-only mortgagee. By taking on this kind of loan, you are relying on receiving more income by the time the principal payments kick back in, either through employment or through your investments. Interest-only terms last a maximum of 10 years, depending on the lender, so you can't rely on it for the whole lifetime of your mortgage.

Ultimately, an interest-only loan could be right for your needs, but it always pays to explore all your options that may be more risk-free before committing fully to the idea. 

That's where Squirrel comes in. We have years of experience in matching Kiwis with the right loan, interest-only or otherwise. If you're considering taking on a new mortgage, come and speak to us first for impartial advice on which financing option is right for you.