Investors often prefer to pay interest-only on their home loans because it helps their cash flow. Low repayments allow them to spend more of their money on other properties, meaning such loans can be beneficial in portfolio building.
However, the end of an interest-only period can bring with it a significant increase in monthly repayments. You’ll start repaying the loan’s principal, as well as its interest, which could put a strain on your cash flow and prevent you from further investing.
You don’t have to allow the interest-only period to end. In fact, most lenders allow you to extend it.
Should I Extend My Interest-Only Period?
Before you jump in, you need to ask yourself if an extension is the right choice. After all, every month of an interest-only loan is a month where you don’t repay the principal. This means the interest doesn’t fall, plus, it may lead to you having to pay a large lump sum at the end of the loan period.
Extending an interest-only loan works best in the following situations:
- Financial issues prevent you from making principal and interest (P&I) repayments
- You want to buy another investment property
- You need the money to pay other loans, such as car finance
- Your mortgage has not yet been paid.
However, you should avoid extending if:
- You don’t want or need to buy another investment property
- You’re earning enough to comfortably repay a P&I loan
- You have no extra debts to repay.
Consult one of our mortgage brokers if you want to discuss whether extending an interest-only home loan could affect your personal circumstances.
How Might Paying Interest-Only Affect My Ability to Borrow?
Lenders look at serviceability when deciding on whether to grant a loan. This term refers to your ability to repay the loan.
Paying interest-only affects your serviceability. For example, let’s assume you have a 30-year loan, and you repay interest-only for 15 years. You won’t have reduced the loan’s principal for those 15 years. As a result, your lender will have to examine your serviceability over the 15 years when you will make P&I repayments. You essentially halved your home loan period, which will make the lender warier of you as a borrower.
How Long Can I Extend an Interest-Only Loan for?
It depends on the lender and your situation. The major banks tend to limit you to five years because they want you to start repaying the loan’s principal.
However, it’s possible to extend your interest-only payments to 15 years. You’ll need to use a specialty lender for this. Some even offer extra features with extended interest-only loans. For example, you may be able to make extra repayments whenever you want. You’ll also usually be able to end the interest-only period whenever you want. This strategy does come with some disadvantages, so it’s important to get help from an expert to fully understand what’s involved before making any decisions.
How Do I Apply for an Extension?
Again, you have to consider your lender’s policies. Some will happily extend your interest-only period over the phone, or ask you to fill out a simple form. Others will reassess the entire home loan. Remember that extensions make lenders nervous. Your request may be seen as a sign that you can’t afford the repayments.
As a result, most lenders reassess your situation if you ask for an above 5-year extension. In this situation, you will probably have to submit another home loan application. That means pulling all the documentation together and going through the process again.
You may also get the option of extending your overall loan period. For example, if you want to pay interest-only on a 30-year loan for 10 years, some lenders will allow you to extend the later P&I repayment period to 30 years. This would mean that your loan takes 40 years to repay. You can opt out of this loan extension if you feel you’re financially stable enough to make the P&I repayments in a shorter timeframe.
What Makes a Lender Reassess My Loan?
Your lender will usually want to reassess your loan in the following circumstances:
- You want to extend the interest-only period beyond five years
- There’s a record of missed mortgage repayments on your credit report
- You live in the home you want the extension for.
Can I Extend an Interest-Only Loan on a Residential Property?
It’s possible, but a lot of lenders shy away from such extensions.
It comes down to the National Consumer Credit Protection (NCCP) Act 2009. This places an obligation on lenders to dig into the details of their borrowers when they ask for unusual products. As a result, a lender may refuse a residential loan extension because they feel it will reduce your ability to repay the loan’s principal.
What Else Do I Need to Know?
There are several other things to keep in mind if you want to extend your interest-only period:
- Many lenders combine their fixed-rate periods with their interest-only periods. You may find that your interest-only extension switches to a variable rate. However, you may be able to extend your fixed rate alongside your interest-only repayments.
- You can avoid the fees that lenders charge for switching to P&I. Call your lender and ask them to increase your automatic monthly repayments. You’ll still be on an interest-only loan. However, you’re paying more than you need to, so the extra money goes towards repaying your principal. You can do this until your loan naturally reverts to P&I repayments.
- Most lenders charge a small fee for extending an interest-only period. This is usually no more than $300. However, you can usually avoid this fee if you have a professional home loan package.
What to Do Next
You have to think carefully before extending an interest-only home loan. Remember that your loan’s principal won’t decrease if you only pay interest. This could result in a nasty surprise waiting for you at the end of your loan’s term. Do the following before you request an extension:
- Check out our infographic about interest-only loans
- Work out how much extra an interest-only loan may cost you
- Live chat with an uno home loan consultant.
This information is general in nature and you should always seek professional advice when making financial decisions.