Milestone Lending Solutions

Principle & Interest vs Interest only

The first one is the type of loan repayments. You need to think about whether your goals are to repay your loan quickly, or to maintain your cashflow.

When you make an application, you will be given the option of a Principal and Interest Loan or an Interest only loan. Some things to consider are:

Principle and Interest – You are making repayments against the interest charged and the amount that you have borrowed (the principal). As a result, generally the total repayments are higher but the interest rate can be lower. The repayment amount is calculated so that over the term of the loan (which could be 20 or 30 years), you will repay all of the loan. This also means that over the term of the loan the total interest paid is less.

Interest Only loan – You only pay off the interest being charged to the loan. During the interest only period (which is generally 3 or 5 years) you do not pay anything off the principal. Overall repayments are lower, but the interest rate is generally higher. For investment properties this type of loan is generally more tax effective.

One thing to know about interest only loans is that the interest only period is only a few years. The loan will then convert to a Principle and Interest loan and repayments will be set over the remaining term of the loan. So you might find that you have a cashflow issue if you have been used to just paying interest only. In addition, interest only loans may not allow you to add extra features to your loan, such as offset accounts.

Fixed vs Variable rates

The second thing you should think about is why type of interest rate you are looking for.

A fixed-rate loan maintains the same interest rate over a specific period of time. Loan repayments and the interest rate on fixed rate loans will remain the same for a fixed period, which is usually 1, 2, 3 or 5 year periods. Choosing a fixed rate loan, which effectively locks in an interest rate and guards against possible future fluctuations, can be attractive.

Fixed-rate loans usually come with a few provisos:

borrowers may be restricted to maximum payments during the fixed term and can face hefty break fees for paying off the loan early. These negatives are weighed up against having some certainty over the amount of your loan repayments. Fixed rate loans also may offer some security against interest rate rises.

A variable-rate loan charges interest according to market rate fluctuations. The interest rate and therefore the repayments on a variable rate loan will go up and down over the term of your loan based on the underlying rate.