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Pros and Cons of Interest-Only Loans

There has been lots of talk in the market about interest-only as an option for homeowners struggling with their repayments. We always recommend you chat to an adviser before making the switch if you are considering.

Interest-only loans have emerged as a strategic tool for homeowners, especially as cost of living has increased and repayments have become tighter to meet.

They offer both advantages and drawbacks that prospective buyers should be mindful of. Let's delve into the pros first.

The main draw of interest-only loans lies in significantly lower repayments. This becomes particularly attractive for those venturing into property investment or assisting their children in purchasing a home. The key pro here is enhanced cash flow, providing borrowers with more financial flexibility.

However, as with any financial strategy, there are cons that demand attention. One prominent drawback is the potential for negative equity. If the property market experiences a downturn, borrowers who have opted for interest-only loans may find themselves owing more than the property's current value. This is a crucial consideration and underscores our duty of care to clients.

Another nuance to bear in mind is the fixed nature of the loan term. If a borrower chooses to fix the loan for a specific period, let's say two years, and borrows $500,000, after two years, the loan remains at $500,000. This can present challenges if the property market has shifted during that time.

At NZ Mortgages, our commitment to clients includes transparently communicating the advantages and risks associated with interest-only loans. While the appeal of lower repayments is evident, we consistently stress that, if financially viable, continuing to pay both principal and interest repayments is the best financial strategy for paying off your entire loan as soon as possible. This ensures a steady reduction in the loan amount over time, contributing to long-term financial stability.

The attractiveness of interest-only loans also fluctuates with prevailing interest rates. In periods of higher rates, the appeal may diminish as interest-only payments are still high, but can be valid if you do need a financial break. However, when rates are low, say, 3.5%, interest-only loans can become attractive. Consider this:

Purchasing a $600,000 property with interest-only repayments could yield repayments of less than $400 per week, a stark comparison to the approximately $950 per week with principal and interest payments.

In conclusion, interest-only loans present a nuanced financial strategy, offering lower short-term repayments but carrying risks, especially in a dynamic property market. Our mission is to empower clients with comprehensive insights, enabling them to make informed decisions aligning with their financial goals.

Key Words: interest-only loans, property financing, pros and cons, cash flow, negative equity, fixed loan term, duty of care, financial flexibility, principal and interest repayments.