Interest only loans

We just got our letter of unconditional approval for finance this morning (yay!). However, it turns out our broker messed up our application and got us an interest only loan for the first 2 years. We specifically told him we wanted to start paying principal as soon as the house was finished, but he obviously wasn't listening. He told us it doesn't matter, that we can pay the principle+interest amount like we had planned anyway, and the loan should be drawn down the same as if it were a principal+interest loan (it simply gives us an option to pay the interest only if we are in financial strife). Does anyone know if this is correct? It makes sense, especially since we'll be making repayments weekly; the interest should adjust after each payment so that if we pay principal as well as interest, our interest should go down like a normal loan. Right? I really hope so... There is nothing we can do to change it now apparently. It's a 3 year fixed rate loan, and we'll have no offset account, but we are allowed to make extra payments.

I am no expert... but I *think* the way it works for interest only is that your required repayment is the interest (plus any charges), so the amount you owe - the principal - remains unchanged. Therefore, any extra you put in is immediately reducing that principal. *shrug* I would presume that the interest is recalculated if you can make extra repayments but that is certainly a question I would be asking the broker and confirming with the lender!

If you can put in the extra repayments and all else being equal (notably fees, interest rates & suitable recalculation of interest owed when the principal is reduced), then it appears logical that you wouldn't be worse off. The actual interest rate you're locked in at and how much above the minimum you can pay will probably have more influence than interest-only. Over the first three years, you're still only barely scratching at the principal of a home loan unless you are putting in a decent chunk above the minimum repayment.

With fixed interest only loans I thought the minimum repayment is set for the term of the loan. If you put extra onto the loan it will reduce the principal owing but it won't change the minimum repayment amount or interest charged....

But is it interest only fixed rate or a fixed rate paying the principal and interest? Ours is going to be fixed and we can't put more then about $10,000 a year in, though it may be less then that..... Otherwise it is considered we have broken the fixed loan....
The reason you get a discount with fixed rate loans

But this stuff starts to get confusing so you fight need to check the info with your bank... Also go back and look at the paperwork you signed with the broker, ours had the loan type we were applying for.

Minimum repayments on interest only loans are just that, interest only. So if you don't put any extra money into the loan, it will be the interest calculated on the same principal amount all the time. However, if you pay down the principal (or in the case of an offset account, have money in the offset), then the interest will be calculated on the principal amount less than the extra repayment (or offset balance), and the monthly repayment will be based on that new figure (obviously will be less).

In your case MalinViktoria, if the loan allows it, then yes the principal will reduce with extra repayments. However you need to be wary with fixed rates loans, as there is generally a limit to the amount of extra repayments are allowed per year without penalty, and you need to clarify if you are able to access redraw for the extra repayments if this is something you might be considering (as some fixed rate products don't allow redraw).

As for you being told there is nothing that can be done about it now, that is codswallop in my opinion, your broker should be able to do a loan application amendment or variation. I've done this before for clients. I think your broker just doesn't want to do some extra work.

Cheers

Tom

If you wanted to pay down your debt ( PPOR) asap than you should get the broker to contact the bank and change the application to an P/I application- should only take 24 hours and it's a matter of getting a re-approval ( which should be fine) and new docs sent out ( total 3-4 days)

Interest only "normally" is the same as P/I IF it was an variable rate with an offset account....given your one is a FIXED rate with NO offset...you will be paying the highest amount of interest at all times ( since interest is compounded daily).

Most fixed rate has a MAX that you can pay extra towards the principle- it ranges from $5,000- $20,000 depending on the lender.

Shouldn't this mean that the interest would adjust according to what is left of your loan and therefore make it less the more you pay?

^ only if you have an variable rate with an offset or redraw ( offset preferred)

I just got some clarification from our broker. Apparently there is a $30,000 limit to extra repayments, which is fine, we won't pay that much extra. He also assured us 100% that the interest will adjust according to our payments, so we won't pay any more than we would have with a p/i loan.

Its correct. If you pay more than the interest amount, its just like paying the principal, however the extra you've paid will be available in a 'redraw', rather than reducing your principal. But as long as you reduce your balance, thats all that matters, thats what your interest is calculated on. Plus, you can always ask your bank to reduce your limit at any time.