Interest only repayment calculator

What the interest only calculator is showing you

An interest only repayment is the simplest sum in home lending: the balance multiplied by the annual rate, divided by the number of payments in a year. There is no amortisation because nothing is being amortised.

Take an example $600,000 loan at 6%. The monthly interest only repayment is $3,000, against $3,597 if the same loan were principal and interest over 30 years. That is $597 a month of breathing room, or 16.6% off the payment.

Because the payment is a flat percentage of the balance, it also moves the moment the rate does. A variable interest only loan passes a rate rise through in full, with none of the cushioning a principal and interest loan gets from a falling balance.

The jump when the interest only period ends

At the end of the period the loan converts to principal and interest, and the repayment does not rise gently. On the example loan with a five year interest only period, the payment goes from $3,000 to about $3,866 overnight, a jump of $866 a month or 28.9%.

1. 1

   The same debt is still there

   You start the principal and interest phase owing the full $600,000, because none of it has been repaid.

2. 2

   There are fewer years left to clear it

   A five year interest only period inside a 30 year term leaves 25 years, so the principal is now spread across a shorter run of payments.

3. 3

   The interest that was never paid down is still being charged

   Interest keeps accruing on the full balance right through the period, so the loan enters its repayment phase carrying more cost than it otherwise would.

Doubling the interest only period from five years to ten does not double the problem, it more than doubles it. The jump goes from 28.9% to 43.3%, because the remaining term shortens from 25 years to 20 while the balance stays at $600,000.

What the interest only period costs over the full term

The last rows of the panel compare total interest with and without the interest only period. On the example loan, five years of interest only means about $739,700 of interest over 30 years against about $695,000 if it were principal and interest throughout.

That is roughly $44,700 of extra interest, and it buys you $597 a month for 60 months, which is about $35,800 of cash flow. You pay about $1.25 in extra interest for every dollar of repayment you defer.

Run your own figures above rather than working from this example. The extra cost scales with the balance and hard with the rate, so a larger loan or a higher rate makes the gap wider than the one shown here.

When interest only is the right call

There are real reasons to structure a loan this way, and they have one thing in common: something specific and identifiable changes at the end of the period.

• An investment property, where the interest is generally deductible and the strategy is to hold rather than to pay down
• Genuinely lumpy income, where cash arrives in a few large amounts a year rather than fortnightly
• A construction period, where you are paying interest on progressive drawdowns and a rent at the same time
• A defined, short cash flow gap, such as parental leave or a business at a known turning point
• Holding a former home as a rental while the loan on the new one is the debt you actually want to reduce

What is not on that list is affordability. Using interest only to get into a house the principal and interest repayment will not stretch to postpones the problem instead of solving it, and it postpones it into a period where the repayment is higher than the one you could not manage.

How lenders assess an interest only application

Borrowers are regularly surprised by this: asking for interest only usually reduces what you can borrow rather than increasing it. Lenders generally assess the application on the principal and interest repayment over the shorter remaining term, not on the lower payment you would actually make.

On the example loan that means being tested against something in the region of $3,866 a month rather than $3,000, and then buffered on top of that. The low repayment helps your cash flow and does nothing for your serviceability.

• Expect the assessment to run on the shorter principal and interest term, not the interest only payment
• Expect a buffer of around three percentage points on top of the rate, as with any home loan
• Expect to explain the purpose of the interest only period and what changes at the end of it
• Expect owner occupier applications to face more scrutiny than investment ones

Extending the period at the end is a new application, not a phone call. Your income, your expenses and your credit file are all reassessed at that point, and a household whose circumstances have tightened is exactly the household that will not pass. Plan for the conversion, and treat an extension as a possibility rather than an assumption.

What the interest only loan calculator leaves out

Everything above is arithmetic on five inputs. It is a general estimate, it takes no account of your circumstances, and it is not an approval or an offer from any lender.

• It holds the rate steady across the whole term, including through the conversion
• Interest only rates are commonly priced above the equivalent principal and interest rate, which the tool cannot know
• It excludes package fees, application fees, lenders mortgage insurance and any other loan cost
• It assumes the loan converts on schedule, with no extension and no refinance
• It does not model extra repayments, an offset balance, or rent and tax on an investment property

The second point matters more than it looks. If the interest only rate is higher than the principal and interest rate you could otherwise have, the true cost of the structure is larger than the figure on the panel.

Which lenders will write an interest only loan for your situation, over what period and at what price, varies widely across our panel of more than 40 lenders. That is a conversation worth having before you apply rather than after a decline. Call us on 1300 813 113.