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  • A Deep Dive into Principal & Interest Vs Interest Only Repayments

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Introduction

When you apply for a loan, you will often have to choose between Principal & Interest (Principal & Interest) payments and Interest Only  repayments.  As the name suggests, with Principal & Interest payments, you are paying your lender the interest cost for the month plus a portion of the principal you have borrowed. Over time, your loan balance will reduce.  With Interest Only payments, you are only paying your lender the interest cost for the month so your loan balance will not reduce.

The type of payment you choose (between Principal & Interest and Interest Only) is  likely to impact the interest rate you are charged.  In the data below, sourced from the RBA’s most recent set of statistical tables (current as at October 2020), you can see that there is a 0.7% pa premium to have an Interest Only facility compared to a Principal & Interest facility.

Further, depending upon a lender’s perception of the current market risk as well as your personal risk, they might not be willing to offer you an Interest Only option, preferring you to take up a Principal & Interest facility.

Lenders typically favour Principal & Interest as it reduces your loan and therefore their exposure over time.  It also fits in nicely with their expected end goal: that your loan is repaid.  Whilst you can repay your loan by selling your property or refinancing with another lender, repayment of the loan in a steady repayment stream over the life of the loan is often seen as preferable by lenders.

 

Principal and Interest Payments

Features

– The monthly repayment is based on the current interest rate, the loan term and the balance required at the end of the loan term.  For a Variable Rate loan over a typical 25 loan term, the balance at the end of the loan term is normally set at nil.  If, however, you had an Interest Only facility for the first three years of your loan, the Principal & Interest  monthly payment amount for the remainder of your 25-year loan would be higher than if you opted for a Principal & Interest facility from Day 1 as there will be three years fewer in which to repay the principal amount.

– As can be seen below, the amount of the Principal & Interest repayment devoted to repayment of the principal increases over time as the interest is calculated on the principal balance remaining at the end of each month.

Note: This analysis excludes fees and charges.

– The higher the interest rate at the time you take out the loan, the higher the overall repayment and the greater the proportion of the repayment which will be devoted to paying the interest (and proportionally less will be devoted to the repayment of the principal).

Note: This analysis excludes fees and charges.

 

Pros of Principal & Interest Payments

– As noted from the RBA data, you may receive a lower interest rate so more of your repayment can be allocated to a reduction in principal.  For example, over a year, for a $500,000 loan, if the Principal & Interest rate is 0.5% pa interest rate lower than the Interest Only interest rate, then this difference can be used to repay a further $2,500 in principal.

– Because Principal & Interest  payments are considered more prudent by lenders, a loan with a Principal & Interest facility is often easier to obtain.

– Every time you make a reduction in the principal owing, there is a compound effect on the amount of future interest you have to pay as with Principal & Interest, the interest you pay is based on the balance of the loan outstanding at the beginning of the month.  (This is why making additional or slightly higher payments each month is recommended as the benefit of the principal reduction has a compounding effect for the balance of the loan period).

– There is an inherent reduction in stress levels when you are reducing the principal owing – sometimes the satisfaction of seeing the balance reducing can give you a nice internal smile at the end of a day!

 

Cons of Principal & Interest Payments

– Your cash payment is higher each month as you are paying your interest plus a portion of the principal you borrowed.

– For Investors, part of your cash flow is tied up on non-tax deductible repayments (i.e. the repayment of the principal).  Please seek independent tax advice before considering this issue.

 

Interest Only Payments

Features

– Each month, you only pay the lender the interest you owe.

– At the end of the month, the same amount is owing to the lender as was owing at the start of the month – and this does not change during the term of the Interest Only loan.

 

Pros of Interest Only Payments

– You do not need as much cash flow available each month to make the monthly payments.

– There may be tax deductible benefits for Investors.  For this, please seek independent tax advice.

 

Cons of Interest Only Payments

– As noted in the RBA data, your interest rate may be higher than if you had selected a Principal & Interest product.

– It can be harder to obtain than a Principal & Interest product as many lenders have a natural bias in favour of Principal & Interest products.

– Your loan balance does not reduce.

– In times of tough economic conditions, if housing prices suffer a fall in value, you may find it harder to obtain refinance as your loan to value ratio (LVR) may have increased more than if you were paying Principal & Interest payments.

– When it comes time to revert to a Principal & Interest repayment, your payments will be higher than you would have paid at the beginning of your loan.  Based on the above examples, at an interest rate of 3.0% pa, on a $750,000 loan over 25 years, the Principal & Interest payment is $3,556 per month.  If you had a 5-year Interest Only product and then reverted to Principal & Interest at the end of the 5-year period, your Principal & Interest payment for the remaining 20 years would be $4,159 – an increase of $603 per month.

– An Interest Only  facility can be more stressful for some borrowers who like to see some gains for all the money they pay out in interest as the amount they owe their lender does not decrease.

 

Our take

– This is the same as our view for variable and fixed rates.

– While lower repayments for an Interest Only facility can seem intuitively better as you reduce the impact on your monthly cashflow, you are also delaying the repayment of the principal and so you are paying more in interest. For some borrowers, this trade-off is worth it as it allows them to enter the housing market and get started; or, it allows them to maximise the benefit of potential tax advantages if they are an Investor (again, seek independent tax advice on this issue).

– As with our comments on variable and fixed rates, it is important to note that everyone is different and everyone’s appetite for risk is different so there is no ‘one answer is correct’ advice. And, when you are dealing with joint applicants, you need to take into account the risk profile of each applicant. Just because one applicant might be comfortable with a higher level of perceived risk,  the other applicant might be a little bit more conservative; so you need to balance the attitudes of both applicants.

– As part of our due diligence when we assist you in identifying a suitable loan, we undertake a Needs Analysis for each person applying. We ask you what your level of concern is about rising interest rates. We also ask you if you would like to consider a fixed rate loan, either in part or in full, and we go through with you all the features, pros and cons.

– We always ask ’Who is on your team?’. What we want to know is, have you got a great team of advisors to assist you in making important decisions? Because when you are dealing with loans of hundreds of thousands of dollars, you need knowledgeable, ethical professionals advising you of your risks.

Before we start….

For further content, please visit https://www.bir.net.au/blog/

And, if you would like a Free Property Report, you can order yours here: https://www.bir.net.au/report-request. You can obtain a report for a particular property, suburb or region in Australia, so you can make informed property decisions. Plus, our suburb reports now provide a comparison report of up to 5 suburbs you want to research.

Any questions, please ring me, Michael Royal 0411 190 474 or email me: michael.royal@bir.net.au. And you can also book a meeting with me: https://calendly.com/michael-royal/chat-re-finance

Now, back to the Article! 😉

 

Interest – what is it?

Interest rates reflect the price of money.  The interest rate ‘price’ factors in a large number of variables including the lenders’ competitive environment and their need to be profitable.

Unlike most transactions with a supplier, your financial umbilical cord with a lender lasts a very long time – often up to 30 years.  This element of time differentiates a lending product from most other consumer products.  When you borrow money from a lender, there is an expectation by the lender that you will pay them back in full on the terms you have agreed and that you will also pay them ‘the price’ – or interest charges – for borrowing their money over the term of the loan.

Whilst it is arguable the ‘time risk’ reduces as years go by as property prices tend to increase and loan balances tend to decrease, there is an inherent risk, particularly in the early years of a loan.  Lenders protect themselves from the potential risk of handing over large quantities of money by adding a margin on the interest rate they charge. Some won’t lend to particular types of borrowers because of the perceived risk.

 

What we know about interest

1. The longer the term of your loan, the more you will pay in interest. Interest rates matter, but so does the term of your loan. That is why when you consolidate your debts from higher interest credit cards into your lower interest home loan, it is important to pay off the debt you consolidated into your home loan as quickly as possible.  If you pay it off over the full term of your home loan, you may well end up paying more in interest than if you paid it off over a much shorter period at higher interest rates.

For example, a credit card/personal loan debt of $100K incurring interest charges of 18% pa, will incur an interest expense of $18K over 12 months.  The same debt, paid off over 25 years as part of your home loan at 3.0% pa, would cost $42K in interest .  Even allowing for the ‘time cost of money’ (i.e. a dollar today is worth more than a dollar in the future), this is a large difference.

It is also why paying additional amounts or slightly higher amounts each month than you are contractually obligated to pay is recommended. You will reduce your principal more quickly and thus pay less total interest.

For example, a $750K loan paid off over 25 years on a P&I basis at 3.0% pa interest, will incur $317K in interest charges.  If the loan term is 20 years, with the same interest rate, the interest charges will be $228K – $89K less.

 

2. Interest is the main expense charged by a lender.  But it is not the only one.  Whilst other costs such as monthly fees and charges, annual establishment fees etc might appear minor, they still have to be paid.

 

3. Interest rates change over time.  Even fixed rates are only for a limited time (generally up to a maximum of five years).  When you enter into a loan agreement with a lender, make sure you can afford the loan and allow for any increases in the interest rate. Our interest rates are at historical lows but less than 10 years ago rates for home loans were in the high single digits.  And, for those old enough to remember ‘the recession we had to have’ in the early 1990s, you will recall rates of well over 15% pa with the highest rates an eye-watering 20%+!.

Hi,

We’ve made it to spring! As the season changes, so does the property and lending landscape. Here are four stories making headlines right now: 

– Rentals being snapped up

– Houses v units

– Prices surge for new land

– Savings rates above 3% p.a.

 

Read more below.

 

But first….

The results of our recent survey

What is the most important quality of a

mortgage broker?

Our thoughts on this survey

Objectivity – 48%

Objectivity is so important. And, our policy of always being totally transparent allows us to demonstrate our objectivity.

To achieve transparency, we use a filtering process – which we share with you every step of the way:

1. We identify who will lend to you in your circumstances (these days, everyone’s circumstances are different).

2. We then clarify a lender’s willingness and capacity to lend to you with their humans – just to make sure. 

3. Only then do we check the rates for those who can and will lend to you.

4. From this rate review, we will give you the short list of these ‘willing and able’ lenders – to get your input via a discussion with us.

5. And only then do we finalise our recommendation.

 

Communication – 31%

Whilst transparency is key, so is communication. 

With your loan, we communicate with you in a number of ways. 

1.  To save you time and to avoid errors and duplications, we use technology to gather information about you as well as receiving your documents which lenders will need to see. 

2. We will regularly ring you, SMS you and email you (and sometimes a combo as we all know how emails, voice mails and even SMSs can be missed or overlooked when we are busy!).

We also follow a 3-day follow-up process – which you can of course vary at any stage (faster or slower).  Every 3 days we will reach out to you to make sure you don’t need any help or time to get the next bit done.

 

Simple to use processes – 14%

Our processes have been designed to be easy to use.  However, where you need us to vary our processes to suit you, we will do so!  After all, we are here to serve you! 

 

Speed – 7%

Speed is important but speed without Objectivity, Communication and Ease of use is not worth a lot to you.  And, dare we say, we know of some brokers who are ‘fast to lodge’ but then have to backtrack when the lender they have chosen says ‘no’.

We see our role as avoiding (or at least minimising) the risk of you receiving a lender No.

 

And, a quick sample of our free services for you!

Rate Checker

Every year (as a minimum), for our clients with a Variable Rate loan, we will do a rate check for you (if you have a settled loan with us, you will get an email to get this started).  We will do the following:

1. Check your rate with your current lender’s best rate for the same product you have.

2. Find a comparative rate for a similar lender with a similar product.

3. Write to your lender or use their online broker portal to request a rate review.

4. And hopefully, we can come back to you with some good news regarding a sharper rate! 😉

It’s a simple process and all you need to do is send us your most recent bank statement and any subsequent rate change advice from your lender.

 

Property Reports

Via our Free Property Report link www.bir.net.au, investors and homeowners can:

– Order a free property report for a particular property.

– Order a suburb report or a comparison of up to 5 suburbs.

– Access detailed regional reports (over 30 including the capital cities) which include a Property Clock (is it time to buy, hold or sell?).

In September, we updated reports for:  Canberra  [ACT]  <  >  Launceston  [TAS}  <  >  Melbourne  [VIC]  <  >  Mackay  [QLD]  <  >  Wollongong  [NSW]  <  >  Darwin  [NT].

 

Property investors are enjoying strong demand for their rental properties right now, with that demand expected to further increase.

The number of homes available to rent has been trending lower since the pandemic began, with listings in July 2022 31% lower than March 2020, according to realestate.com.au.

As a result, tenants are being forced to compete harder, which is leading to rising rents and lower days on market.

“Australia-wide properties are renting faster than ever, and the number of days it took a rental property to be leased after it was listed on realestate.com.au in July hit a historic low 19 days,” according to the portal.

REA Group senior economist Eleanor Creagh said a “surge” in international student arrivals would add further pressure to tight capital-city rental markets.

“In fact, overseas searches to rent have also skyrocketed in recent months, in the last six months compared to the six months prior overseas rental search volumes are up 59% with the borders having reopened,” she said.

 

Houses have significantly outperformed units over the past three decades, according to CoreLogic.

During the 30 years to July 2022, median prices increased 453% for houses compared to 307%.

That outperformance occurred in every capital city market:

– Sydney 507% v 340% (houses v units)

– Melbourne 519% v 354%

– Brisbane 390% v 170%

– Perth 325% v 194%

– Adelaide 370% v 289%

– Hobart 423% v 296%

– ACT 431% v 261%

– Darwin 98% v 96%

CoreLogic said the faster rate of growth for house prices was “likely a reflection of the scarcity value of land driving a faster rate of appreciation”.

During the same 30-year period, capital cities (409%) recorded significantly more growth than regional markets (294%).

“The higher growth rate across the capital cities probably reflects a combination of higher demand and greater scarcity of supply compared with regional markets, along with more diversified economic conditions within the capital cities,” according to CoreLogic.

 

New research by the Housing Industry Association and CoreLogic has found that the supply of new residential land is failing to keep up with demand.

Median lot prices in the March quarter were 19.7% higher than the year before, based on an analysis of 51 housing markets across Australia.

HIA senior economist Nick Ward said this was the strongest annual growth rate since 2004.

“An unusually sharp rise in the price of residential land indicates the supply of land is not keeping up with new demand that has emerged during the pandemic,” he said.

“Constrained supply of land will limit housing activity in greenfield areas from mid-2023 onwards.”

CoreLogic economist Kaytlin Ezzy said the increase in land prices was connected to a reduction in the number of lots sold.

“While increasing interest rates, rising construction costs and increased uncertainty, particularly across the building industry, has likely smothered some land demand, the surge in land prices suggests that those that want to build are finding it difficult to secure lots,” she said.

“With land often taking more than a decade to move through the development pipeline, it’s unlikely we’ll see any material change in land supply for some time.”

 

Rising interest rates are bad news if you’ve got a home loan. But they’re a blessing if you use savings accounts.

Six banks are now offering ongoing savings rates above 3% p.a., according to a RateCity analysis of the market.

Research director Sally Tindall said if your savings rate is below the cash rate [currently 2.35% p.a.], you’re being taken for a ride.

“There is competition in the market, you just have to get up and look for it. In this environment, a good rate is around 3% p.a., potentially even more,” she said.

 

How to get an even higher interest rate

If you have a home loan, there’s a way you can earn an even higher interest rate – by depositing money in your offset account.

The money in your offset account reduces the interest-bearing portion of your home loan by the same amount. For example, if you have $500,000 outstanding on your loan and $40,000 in your offset account, you’ll be charged interest on only $460,000 (i.e. $500k minus $40k).

As a result, the return you get on offset deposits is equivalent to your mortgage rate, which will almost certainly be higher than the rate paid by a conventional savings account.

We are often asked “Why should I refinance my loan?” If you ask the Australian Consumer & Competition Commission (ACCC), the answer is clear:

Most borrowers are paying far higher amounts to their lenders than the best rates currently available in the market.

And, the major banks are probably the biggest offenders as their ‘carded variable rate’ is much higher than the best rates they offer their new customers.

The ACCC provided the following information in 2020 for variable rate loans.

 

 

 

 

Length of time with loan Weighted average premium being paid by existing borrowers
(per annum)
%		 Impact per $100K borrowed
(per annum)
$		 Impact on a $500K loan
(per annum)
$
Less than 1 year 0.28% pa $280 $1,400
1 to 3 years 0.47% pa $470 $2,350
3 to 5 years 0.58% pa $580 $2,900
5 to 10 years 0.71% pa $710 $3,550
Over 10 years 1.40% pa $1,400 $7,000

 

 

Do the maths for you and your loan:

Loan repayment calculator

 

Your DIY solution

Step 1: Do the research

Step 2: Talk (to your bank)

Step 3: Success! Follow up needed

Step 4: Eternal Vigilance

 

Step 1: Do the research

Everything starts with research.

Go online to your lender’s website and see what their current advertised rate is for your product, then, compare it to the rate shown on your loan statement.

Go to a rate checking web site and see what the best rate is you think you could get. This can be a bit tricky if you are not comparing like for like with your loan’s product features.

Hints:

1. Make sure you know which product you have with your lender before you start your research. Different products will have different features and different rates.

2. Get a copy of your current loan statements. Online is often easier these days via your lender’s online portal unless you are being mailed paper-based copies and you are keeping them handy. From your statement, grab your current rate plus your account details (you will need these for Step 2).

 

Step 2: Talk (to your bank)

Be prepared for some frustration as you are about to experience the wonderful ways lenders make it difficult for their ‘existing’ customers to quickly reach the right person!

Your options: you can try to contact them via their Contact Us on their online portal or via their website; you can send an email (trying to find ‘the right’ email address for this can be tricky ); or, you can ring them –but be prepared for a half hour wait (or longer). Remember, you are not their ‘next customer’; you have already bought from them, so they are not in a rush and urgency is much less (for them).

Show them your research and see if they will match their current best rate for you or even better, match a competitor’s best rate.

 

Step 3: Success! Follow up needed

Once you have communicated with your lender, AND they have promised to reduce your rate to their current rate, it is time to make sure they hold their promise to you –and reduce your rates when they promise to do so. Don’t forget to check your new statements to make sure the rate change has been implemented.

 

Step 4: Eternal Vigilance

Now is the time to watch your lender’s rates for their next rate change. When any lender makes a public announcement relating to a rate change, check your lender and see if they adjust their rate. We recommend doing this a month or so after a lender (not yours) announces a rate change as it can take time for an industry-wide rate change to filter through to all lenders.

 

 

12 good reasons to refinance + a bonus extra!

Other than paying too much of your money to your lender, there are many other good reasons to refinance. Here is a checklist for you to consider.

 

 

 

 

# The good reason
1 You are paying too much in interest because your lender does not adjust your rates to their current ‘sharpest’ rate.
2 Your borrower profile has improved. So, you can obtain a lower rate loan. Perhaps when you first applied, your credit score was impacted or your income was lower but now, you are flying at a higher level.
3 Your property value has increased. Now, you have a lower Loan to Value Ratio (LVR) which will give you a better interest rate with a more suitable product.
4 You have some personal goals. Take a holiday, buy a car, renovate… and you would like to use the increase in equity in your home (its value less your loan) to do just that.
5 You want to build your wealth. Using your available increase in your equity might be able to fund the purchase of another property.
6 You want a more suitable loan product.

Perhaps you thought you didn’t need an offset account but now you have surplus funds earning you zilch interest after tax and if you had an offset account, you could save the full value of your loan interest rate.

Or, perhaps you want to lock in a Fixed Rate loan before you think the rates go up.

Or, perhaps you are on Interest Only and want to change to Principal and Interest to start making a dent in the amount you owe.
7 Your Fixed Rate loan period is about to expire, and the Variable Rate being offered by your current lender is not that attractive (HINT: it won’t be attractive –they are banking (sic)on you not checking).
8 You want to take advantage of benefits being offered by lenders such as Cash Rebates.
9 You want financial freedom. By paying off your loan more quickly (because you can) allows you to think clearly about your future without debt.
10 You want to reduce your financial stress. You can do this by increasing your loan term and paying less each month (but more in the longer term). Still, lower stress is a good thing if things are tight financially.
11 Family issues need to be resolved. As unfortunate as it is, a family break-up will probably require a refinance for one of the parties if they wish to stay in the family home.
12 Consolidate your debts. When life has been a bit stressful and you have personal debts and loans, it can be smart to consolidate your debts into your lower-interest rate home loan. Just be careful you don’t think ‘I’ve got 30 years to pay this off’ as the longer term and ongoing interest repayments will eat into the short-term interest rate savings you thought of when you decided to consolidate your debt.
13 Pay off the taxman. You are a business owner and you have found that your business has got behind in paying the ATO. The ATO may be a bit impatient and want payment sooner than the longer-term payment plan you had in mind.

 

 

So, go to it! Look after you and your family and have a look and see what you can save!

Would you like more information? You can ring us now 1300 989 878 or email us at moreinfoplease@bir.net.au

Michael Royal, our Senior Finance Specialist, is a member of BNI Powerhouse which is based in Altona VIC 3018.  Below is a list of members in his BNI chapter. These are business owners Michael has developed a deeper relationship with and he has either used them himself or others he knows have used them and recommend them as quality suppliers of the services they offer.

 

BNI – some background and context

BNI is a worldwide referral network for business owners who are looking to grow their business. There are over 288,000 members across the globe and many of the members are business owners who are looking to grow their business.

As most of us know, small businesses grow their business by referrals from clients, and fellow business owners they interact with.

But referrals don’t just happen. A referral is only made by someone if they believe the referral is someone who delivers quality services on time and at a fair price. And, when some refers to someone of quality, they are also seen in a favourable light as they become what is often known as a trusted business advisor.

In BNI, the referral process is known as Givers Gain. When I give something of value to my fellow members, in return I will receive something of value. A famous author and psychologist, Robert Cialdini, characterised this as the power of reciprocity.

This power of reciprocity ultimately as two important benefits:

1. The emotional benefit of helping someone achieve a better result. This benefit is experienced by both the ‘referrer’ and the ‘referee’.

2. The financial benefit for the referee from the business they receive.

Interestingly, at a member level, BNI does not measure and track the benefit received but rather, they measure the benefit given as the emphasis is on ‘who can I help?’ not ‘what’s in it for me?’

The total emotional benefit?  Immeasurable; the total financial benefit?  Over USD$18B in 2021.

 

Business who are my fellow members at BNI Powerhouse

Michael’s BNI Chapter is looking for business owners in the following specific business categories. There may be others you know so please don’t limit your thoughts to the categories listed below!

So, if you know quality service providers in any of the categories listed below, please reach out to Michael: 1300 989 878  or visit Contact Us

 

Real Estate / Property / Finance

✔️ Cleaner – windows, facades & solar panels

✔️ Commercial Finance Broker

✔️ Property Inspector

✔️ Residential Mortgage Broker

✔️ Property Manager

✔️ Rubbish removals – building & construction

 

Finance:  Business and Personal

✔️ Accountant – Tax

✔️ Bookkeeper

✔️ Business Advisor

 

Business Services

✔️ Digital Marketing

✔️ Organisation & Process Engineering

✔️ Registered Sporting in Body

✔️ IT Support

 

Trades:  Property, Business & Personal

✔️ Electrical – automation & security

✔️ Plumber – commercial

✔️ Tiler

 

Personal Services

✔️ Lawyer – Family Law & Mediation

 

Health & Wellness

✔️ NDIS – support coordination

✔️ NDIS – support worker services

✔️ Hypnotherapy

✔️ Massage Therapist