Here at Milk Chocolate, we engage in a wide array of different briefs, from investment properties to future principal places of residence to building entire property portfolios as well as construction. We, therefore, spend quite a bit of time handling home loans. It’s incredibly important to be aware of the differences between a principal and interest loan and an interest-only loan as well as the advantages and disadvantages associated with each.
What are they?
Principal and Interest loans are often the most popular type of loan for PPOR purchases. This loan allows the borrower to pay back a portion of the principal (the amount borrowed from the lender) with interest in each repayment. As the principal owed drops, repayments will often be lower further down the life of the loan as the interest payable lowers. Essentially, P&I loans hit two birds with one stone, both interest and principal is paid back simultaneously. This loan also has generally lower interest rates than interest-only.
In contrast, an interest-only home loan is a loan in which the borrower is only required to pay back the interest, however, this is only for an agreed period of time (around 5 - 10 years), not for the entire life of the loan (around 30 years). Due to this, an interest-only loan has lower initial repayments than a P&I loan, as only the interest on the principal is paid. This could be useful during especially cash-strapped periods, during the first few years of the loan, for example. However, the borrower must be aware that interest-only loans equate to “less in the short-term, but more in the long-term”, as once the interest-only repayment period ends, the loan could be more expensive overall when compared to a respective P&I loan, as the principal would be higher, thus resulting in higher interest paid. However, the solution to ensuring that the interest-only loan doesn’t become more expensive than a P&I loan is to take advantage of an off-set (click here to read more about a mortgage offset account) to reduce the overall debt and save on lower interest repayments throughout the life of the loan.
Advantage & Disadvantage Comparison Table
Example Comparison
Source: ANZ
Sources: ANZ Bank | Money Smart
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