Why interest-only home loans are a game-changer to build wealth for retirement

Summary

Discover the potential of interest-only home loans as a strategic tool for wealth building, retirement planning and cashflow flexibility. Mortgages are often viewed as simply large debts, but, with the right strategy, you can actually use them to grow your wealth for retirement or unlock short-term financial freedom when you need it. Find out how it can help:

• Rentvestors

• Growing families 

• Pre-retirees

• Property investors

What are interest-only loans?

Interest-only loans are a type of mortgage where borrowers pay only the interest on the loan for a specified period, without reducing the principal balance. This results in lower monthly repayments during the interest-only term, freeing up cash flow for other financial opportunities or needs. 

Compared to principal and interest home loans, interest-only loans have traditionally been viewed as a less-than-ideal way to pay off a mortgage, as you aren’t reducing the principal balance of the loan, which can mean higher total interest paid over the lifetime of the loan.

However, when used strategically, refinancing to an interest-only loan can be a powerful tool for building wealth and securing a comfortable retirement. It can also be used to free up your cash in the short-term when things pop up in life that you don’t want to miss out on because of lack of funds.  

How it helps: Rentvesting goals

Rentvesting allows you to live where you love while investing in another property that might be more affordable. Interest-only loans can be the perfect sidekick for rentvestors, temporarily offering lower monthly repayments that free up your cash flow to build up your property portfolio.

How does it work? David already has a property and his fixed-rate mortgage is about to roll onto a variable loan, meaning higher repayments. He wants to move out of his property to turn it into an investment, so he refinances to an interest-only loan, which reduces repayments temporarily. Because he’s now using the property as an investment, he can also make the interest tax deductible. The rent he earns from turning his property into an investment also reduces his mortgage repayments – leaving more money to save for future investments.

How it helps: Supporting growing families 

A kid on the way doesn’t mean you have to forgo big expenses. Interest-only loans can be a financial friend during those cash-strapped years. With lower monthly payments during the interest-only period, you can allocate funds towards other essential needs like education, family vacations or home improvements, giving you the freedom to enjoy life while planning for the future.

How does it work? Maddie and Ryan have just had their first child. They bought their home seven years ago, however would like to reduce their home loan repayments to save money to put toward private school fees. Refinancing to interest-only will drop their repayments temporarily so they can save more and put the funds towards their kid’s education.

How it helps: Pre-retirement planning

For those thinking about retirement, interest-only loans are a companion in the journey towards a comfortable future. Choosing to unlock the equity in your home and switching to an interest-only loan can free up cashflow compared to a principal and interest loan, meaning you can supplement your retirement income or fund those long-awaited adventures. Plus, AMP’s 10-year interest-only loan allows you to do this for a much longer period than any other bank, providing certainty and flexibility in how you use your money.  

How does it work? Celina and Vic are approaching retirement and have owned their property for 20 years. Their loan has a very low LVR. They want to access the equity in their home to help their adult child purchase his first home, start a share portfolio and use some money for a European holiday. Their budget is currently comfortable, however they don’t want to have their repayments increase from where they are now from accessing equity in their mortgage with a principal and interest loan. Refinancing to an interest-only loan can allow them to access a big chunk of money while keeping their repayments as they are. It’s important to note, by making only interest payments, they won’t be reducing the principal loan amount, therefore won't reduce the balance of their home loan during the interest-only period. This could be a disadvantage if property values decline or if they plan to sell the property during this time.

How it helps: Property investment strategy

For property investors, interest-only loans can be like holding an ace up your sleeve. With repayments focused solely on interest, you can maximise your tax-deductible expenses while keeping more cash in your pocket. This strategy can allow investors to expand their property portfolio without the immediate pressure of paying down the principal, paving the way for potential capital growth over time. It’s a classic case of letting your money work smarter, not harder!

How does it work? Ajay and Paula are approaching retirement. They own their primary residence outright, but still owe about 70% on their investment property. They would like to spend more time travelling before they retire, however doing this while juggling loan repayments is difficult. They would prefer not to sell their investment property at this time, as there is still strong capital growth potential prior to retirement. Switching to an interest-only loan will free up more cash flow compared to a principal and interest loan so they can save faster toward their travel goals. It’s important that refinancing aligns with their long-term financial goals and that they have a solid strategy for managing the eventual increase in repayments once the interest-only loan period expires. 

Considerations and risks

Switching to an interest-only loan can be a powerful tool in your wealth-building arsenal, but with any financial decision, it’s crucial to consider your individual circumstances and seek professional advice to ensure it aligns with your goals. Some things to remember:

• Once the interest-only period expires, your monthly repayments will increase as you start paying both principal and interest. This can lead to a significant rise in monthly expenses, which could strain your finances if not anticipated.

• Over the life of the loan, you may end up paying more in interest compared to a principal and interest loan. This is because the principal remains higher for longer, resulting in more interest accruing over time. 

• If the property market declines, you may find yourself with negative equity, where the value of your home is less than the outstanding loan amount. This can make it difficult to refinance, sell, or access additional funds.