Browse Forums Home Finance 1 Jul 14, 2011 10:55 pm Hi everyone, we are looking to build our first home and are wondering which of the two is the better option, Interest Only or Principal and Interest? Someone told me that Interest Only would be better since we can put in extra payments anyway and they would go directly to paying the Principal, P&I however whilst the name suggests it, includes hidden charges within it and that the first few years are effectively paying interest only anyway? basically , we're looking for the best setup on how we can pay off the mortgage the quickest we are looking to live in the property and not sell it within the next 5-7 years nor turn it into an IP (not saying we wouldn't but no plans at the moment) thanks for you advice in advanced Re: Interest Only or Principal and Interest? 2Jul 14, 2011 11:12 pm my loan is interest only for 5 years, but it doesn't stop me making additional payment if I can afford. with principal and interest, you are forced to make principal payment every month. Re: Interest Only or Principal and Interest? 3Jul 14, 2011 11:16 pm Hello, There are no hidden charges in a principal and interest home loan - assuming you go with a good lender. Most variable rate home loans allow extra payments with no penalty. There is not logical reason that you would want to do an owner occupied home loan as interest only. Apart from if you were in hardship when you already had the loan i.e had a baby or lost job and needed to drop payments to a minimum for a short period. People generally do interest only on investments loans to keep the interest they can claim at the end of the year as high as possible - whilst paying as much as they can off their home loan. Most people I see that do interest only home loans owe the same now as they will in 5 yrs time. If this is your first home loan go into a bank and talk to an experienced lender so you can get the right advice and get setup on the right product- sounds like the advice you have received so far is very poor. Building with Fairmont Homes NSW at Glenmore Ridge Lot 1007 Our Builder http://www.fairmonthomesnsw.com.au Our Blog http://drewandrenee.blogspot.com/ Re: Interest Only or Principal and Interest? 4Jul 14, 2011 11:17 pm 1st question do you pay your credit cards off in full EVERY month? 2nd question do you save more than you spend EVERY month? 3rd question do you have a lump sum to put against the principal of you loan? we have had an interest only loan for at least 15 years now. The real key it to understand the mechanism and why you are doing it.... we bought a property for 275k which after 10 years is worth about 600k (yeah we got lucky)we paid nothing off the principal but in doing so have in savings another 200k. we now are doing a renno costing over 300k...borrowing to make up the shortfall but the finished house should be worth 900k+. Make sense???? no ??? i guess in short we would be way ahead if we sold but that not what interest only is about. If you intend to live in your interest only house long term its the way to go...if not pay it off quick. Re: Interest Only or Principal and Interest? 5Jul 14, 2011 11:22 pm If it were me I'd personally choose Principle & Interest. I don't like the idea of paying for the loan but nothing coming off the balance. Sure, in the beginning a high percentage of your payments are interest, but at least something (even if it's $20) is coming off the principle, which in turn reduces the interest portion the next month and subsequently increases the principle portion. Custom downslope build Build thread viewtopic.php?f=31&t=61873 Blog http://www.buildingroyalmanor.blogspot.com.au Re: Interest Only or Principal and Interest? 6Jul 14, 2011 11:24 pm sceen7 we bought a property for 275k which after 10 years is worth about 600k (yeah we got lucky)we paid nothing off the principal but in doing so have in savings another 200k. Was it your own home or an investment property? If it was your own home why would you pay interest at 7%+ on $275,000 (which is non deductible debt) and then only to get 5% on your $200,000 in savings - which you would pay tax on Building with Fairmont Homes NSW at Glenmore Ridge Lot 1007 Our Builder http://www.fairmonthomesnsw.com.au Our Blog http://drewandrenee.blogspot.com/ Interest Only or Principal and Interest? 7Jul 15, 2011 7:28 am You would also need to see if your lender will do an owner occ loan on interest only. The main issue here is are you disciplined enough to pay more then you are obligated to? Ie if you are like the vast majority of people and see that your min payt is only the interest component are you going to say oh what the heck this month we will only pay that and next month we will pay extra - and of course the cycle keeps repeating. Which in turn means you never get ahead on your loan. Some things are worth waiting for. Re: Interest Only or Principal and Interest? 8Jul 15, 2011 8:42 am Given that OP is building a first home, I think interest only loan has its place while you are building - I thought many people did that Ie pay interest only whilst building and then revert to Interest and principle after handover, I thought many construction loans were set up like this. Ours certainly was and no hidden charges for doing so (admittedly this was with a credit union and they have less extra charges than banks) - was not a first home for us but enabled us to pay minimum payments on construction whilst still paying mortgage payments on previous house - once we sold that house we could afford the interest and principle loan of new house. If you are paying rent atm, OP, this enables you to pay your rent and the interest only payments of your construction - when you are no longer paying rent you will be able to afford the higher interest and principle loan. With ours we could pay more than just the interest amount if we wanted to - and we did , especially early on in the construction when we only owed the builder the first progress payment or so. Re: Interest Only or Principal and Interest? 9Jul 15, 2011 8:47 am A large portion of normal payments contain mostly interest any. For your residence where you live you better off paying it off as soon as possible. You will always be better off. Unless we are in a boom and you can better more properties this way. Re: Interest Only or Principal and Interest? 10Jul 15, 2011 10:17 am sceen7 1st question do you pay your credit cards off in full EVERY month? 2nd question do you save more than you spend EVERY month? 3rd question do you have a lump sum to put against the principal of you loan? we have had an interest only loan for at least 15 years now. The real key it to understand the mechanism and why you are doing it.... we bought a property for 275k which after 10 years is worth about 600k (yeah we got lucky)we paid nothing off the principal but in doing so have in savings another 200k. we now are doing a renno costing over 300k...borrowing to make up the shortfall but the finished house should be worth 900k+. Make sense???? no ??? i guess in short we would be way ahead if we sold but that not what interest only is about. If you intend to live in your interest only house long term its the way to go...if not pay it off quick. I would love to know how much you paid in interest only over the last 10 years Re: Interest Only or Principal and Interest? 11Jul 15, 2011 11:21 am dtechstr Hello, T There is not logical reason that you would want to do an owner occupied home loan as interest only. Apart from if you were in hardship when you already had the loan i.e had a baby or lost job and needed to drop payments to a minimum for a short period. Incorrect. There are many reasons why interest only is beneficial to an OO (owner Occupier). Seeing this is a first home the chances are the poster will not stay in this home forever. So when they decide to move they have 2 options. Sell or keep it as an investment property. If they decide to keep it as an investment property and have paid off the loan down to (say) $100K then they can get tax deductions on $100K but no deductions on the amount they borrow for their new home. If they have paid interest only and put the extra funds into an offset account they can then withdraw this money to buy their new home and the total amount of the first home is tax deductable. This can save thousands of dollars a year. When money is placed in an offset account it is virtually (in money terms) the same as paying off your loan EXCEPT the money is yours to do with what you want. When you pay off a loan the bank decides if they want to lend it back to you. It's about control of YOUR money. Think about the future. Of course you need to have disciplined to not just take money out of the offset account for holidays etc. If you decide to go interest only and not go the offset account route it's about what you do with the money. If you can make more money by placing money elsewhere do that. If you have credit card debt or a car loan etc you are better going interest free until these are paid off as the interest is much higher on these. It all comes down to managing your money. Re: Interest Only or Principal and Interest? 12Jul 15, 2011 11:23 am generally while you have a construction loan you do interest only. After that time we will be switching to Principle and interest Re: Interest Only or Principal and Interest? 13Jul 15, 2011 11:24 am this doesn't make sense. You need to consider any money that you have on the loan you are saving the interest at the market rate. Anything that you dont pay on the loan and invest else is subjected to additional tax. Re: Interest Only or Principal and Interest? 14Jul 15, 2011 12:35 pm The middle ground is to have an interest only loan with an offset account linked. You make interest only payments into the loan, and pay any extra into the offset. Your interest bill goes down as your offset balance goes up but you keep the flexibility of having the cash to hand if you decide to renovate or having a larger loan if you turn it into an investment at some point. You can also have your wages paid into the offset and pay bills out of it - this keeps your average offset balance higher so less interest again. The downside is how disciplined you are... Paying your loan principle and interest means you have no chance to spend that extra money! If it is sitting in the offset you may think 'I'll just take a little out for that new TV' etc... Re: Interest Only or Principal and Interest? 15Jul 15, 2011 2:24 pm BaysideBuilder The middle ground is to have an interest only loan with an offset account linked. You make interest only payments into the loan, and pay any extra into the offset. Your interest bill goes down as your offset balance goes up but you keep the flexibility of having the cash to hand if you decide to renovate or having a larger loan if you turn it into an investment at some point. You can also have your wages paid into the offset and pay bills out of it - this keeps your average offset balance higher so less interest again. The downside is how disciplined you are... Paying your loan principle and interest means you have no chance to spend that extra money! If it is sitting in the offset you may think 'I'll just take a little out for that new TV' etc... this is exactly what we are doing now while in the construction faze. once we are in we will switch to P&I but still follow the same principle of having the offset account and everything going into that. you are correct, you do have to be disciplined but if you are it works a treat! Re: Interest Only or Principal and Interest? 16Jul 15, 2011 8:46 pm Let get back to the original post... Looking at your first home... don't confuse yourself....get a normal home loan/construction loan and get used to it... then you can get creative later.. Building with Fairmont Homes NSW at Glenmore Ridge Lot 1007 Our Builder http://www.fairmonthomesnsw.com.au Our Blog http://drewandrenee.blogspot.com/ Re: Interest Only or Principal and Interest? 17Jul 15, 2011 11:13 pm thanks for the replies so far, all appreciated. just to be a bit clear, during construction it will definitely be an interest only mortgage, so the debate is whether to stay at that or swith to P&I after construction. we will most likely be living in the property (unless circumstances changes), no plans at the moment to go investment properties or sell the house for profit and start again. Re: Interest Only or Principal and Interest? 18Jul 15, 2011 11:46 pm travelbug When money is placed in an offset account it is virtually (in money terms) the same as paying off your loan EXCEPT the money is yours to do with what you want. When you pay off a loan the bank decides if they want to lend it back to you. It's about control of YOUR money. Think about the future. Of course you need to have disciplined to not just take money out of the offset account for holidays etc. this is sort of the idea basically, whether we go by Interest Only (IO) or Principal & Interest (P&I), we will have an offset account anyway and we might be overpaying every month anyway, not just pay the minimum. In this case, is there any advantage to each option? travelbug When you pay off a loan the bank decides if they want to lend it back to you. i don't quite get this, can you please explain further? Re: Interest Only or Principal and Interest? 19Jul 16, 2011 8:43 am travelbug When you pay off a loan the bank decides if they want to lend it back to you. i don't quite get this, can you please explain further?[/quote] If you pay money off a mortgage and then you want to borrow the money again ( a home equity loan or a re-draw on your mortgage) then it will usually be for "any worthwhile purpose" - thats the wording our credit union uses - so, for example, holidays, renovations, extensions, car, wedding etc. Whereas if it is in an offset account you can withdraw it at any time and use it on absolutely anything you want - blow the whole lot on drink and drugs if you choose . Although "worthwhile purpose" is at the discretion of the bank or credit union, in practice they will lend the money for any sensible use so I dont see the problem. Re: Interest Only or Principal and Interest? 20Jul 16, 2011 10:32 am Hi what I mean is. If you pay your loan off and want more money you need to apply for another loan. If you have a redraw of course you can pull that money out when you apply to the bank. But if you have an offset it's your money. You can take it out whenever you like. The main difference between an offset and a redraw is that with the offset the bank sees it as YOUR money. With the redraw they are giving you the option of taking their money (that you've paid extra) back out. From an investment point of view that makes a big difference. If you do down the track decide to make the property an investment property you can take the money out of the offset and the full loan amount is tax deductable. If it's in the redraw and you take it out you cannot deductable. I can't see the persons point in NOT thinking of the future and JUST get an ordinary loan. It costs no extra to be prepared for the future. The amount of people that stay in their original house for life is very rare. Why bury your head in the sand? 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