Last month I wrote about Interest Only loans and why they may no longer be the best option for you. You can read that article here.
We had a number of enquiries on this topic so this month I am addressing how the move from Interest Only (IO) to Principal & Interest (P&I) works and the impact of switching.
A borrower can at any time request the bank to change repayments to P&I (note moving the other way is not so easy), or the repayment will automatically change to P&I at the end of your initial 5-year period. At that point in time the bank will calculate what you would need to pay each month, based on current interest rate, such that your loan would be paid out in full exactly at the date of the expiration of the loan, for example 25 years.
As interest rates increase the bank will increase your repayment under the same formula. Note where interest rates decrease banks will often not adjust your repayment, in which case you are effectively making higher than minimum payments, which means you will pay your loan off faster. That is a good thing, unless you are in cash flow problems!
In most cases you will move to a lower interest rate in conjunction with the move to P&I. Therefore, the interest cost will be less, even though your repayments are higher.
Don’t panic! The additional repayment amount is paying off your loan, so it is still your money.
What Dollar Difference?
The dollar difference will vary dramatically client to client. As an example, a client with a $400,000 loan pays interest only $1,590 per month. After the 5-year initial period, the loan changes to P&I, the repayment moves to $2,708 pm, with an interest cost of $1,300 pm. The balance of the repayment is paying off the loan.
Where the client needs to preserve cash flow we are able to restructure the loan to P&I repayments of $1,886 pm, in which case the client is only paying an additional $296 pm to the bank (compared to interest only), but is now paying off the loan by $586 pm, and saving $290 pm in interest expense. A great result!
If you are interested in reviewing your loan contact us today.
As seen in the Dingley Dossier.
Daryl Borden, Integrity Finance Australia Ph. 03 9511 8883 ACL 392184