What To Do When The Interest-only Period On Your Home Loan Ends

There is a sleeping problem in the Australian Mortgage Industry, stemming from households who have interest-only mortgages, who will have a reset coming (typically after a 5-year or 10-year set period). This is important because now the banks have tightened their lending criteria, and some may find they cannot roll the loan on, on the same terms. Interest only loans do not repay capital during their life, so what happens next?

Our friends at finder.com.au have put together this guide for households in this position, authored by Richard Whitten*.

Interest-only loans offer borrowers several years of very low mortgage repayments. However, there is always that fateful day when the interest-only period ends, and if you’re not prepared for that moment, it can really hurt. It’s a serious problem, with almost 1 million Australians already facing mortgage stress.

Many borrowers aren’t even aware of what it will mean financially when their loan switches from interest-only to principal and interest repayments. This makes interest-only loans a risky product, and it’s the reason why the Australian Prudential Regulation Authority (APRA) has been cracking down on interest-only lending.

Borrowers with interest-only loans need to be prepared for the day that their loan reverts. When that day comes, borrowers have three options.

Extend the interest-only period

You could try to extend the interest-only period. If you’ve crunched the numbers and you realise that you cannot meet the increased cost of principal and interest repayments, this could really help.

Of course, this is not a good position to be in and your lender could easily refuse your request. However, they probably don’t want to lose you as a customer, and if you’re facing genuine stress, it’s in both of your interests to come up with a solution.

But keep in mind that the bank always wins. Interest-only loans cost borrowers more in the long run compared to principal and interest loans and extending the interest-only period only adds to your overall mortgage costs.

Switch to the principal and interest period

You could opt to do nothing and your loan will revert to principal and interest repayments. However, you should definitely review your loan and your financial position before this happens. Make sure you calculate your new repayment amount so that you’re not caught out.

There are several advantages to this option: it requires the least amount of effort and by repaying the principal of your home loan you’ll finally be moving towards paying off your debt.

It also means that you’re building equity in your home. If you think about the equity in your home as a form of savings, those enormous monthly repayments don’t seem so bad.

But you do have one more option.

Refinance your home loan

You’re a customer, after all, and you’re not locked into your home loan. You could try to negotiate a better rate with your current lender or you could refinance to a completely new lender. This allows you to either switch to a new interest-only loan or find a principal and interest loan with a lower interest rate or better features.

Be sure to compare your interest-only options carefully and read the fine print on both your current loan and the one you’re planning to switch to. You might have to pay various discharge or early exit fees to leave your current home loan and application or establishment fees to begin your new one. You’ll need to balance these upfront costs with the potential long-term savings that come with a lower interest rate.

And as with most things in life, you just need to do your homework.

*Richard Whitten is a member of the home loans team at finder.com.au. His role is to explain all the complexities of the home loan industry in ways that help consumers make better life decisions.

Author: Martin North

Martin North is the Principal of Digital Finance Analytics

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