What is the difference between Principal & Interest and Interest Only mortgage repayments?
The lender requires a mortgage repayment each month, it can be for either Principal & Interest (P&I) or Interest Only (IO).
The key difference between the two types of repayments is that in P&I you are repaying a portion of the principal of the loan amount and a portion of the interest that the lender charges.
For IO repayments you are simply servicing the interest due each month on the principal loan amount.
P&I repayments are always higher for this reason, because you are paying down your loan not just servicing the interest portion.
The benefit of P&I repayments is that you are paying down your loan amount and building equity in your property with each monthly repayment.
With IO repayments generally they are only available for a fixed period of time, for example the first year or two of you mortgage and at most five years. These types of repayments are lower because you are not paying down the loan, but it gives you more cash flow during the period to use.
If you are seeking IO repayments because they are lower it is worth considering that you will be paying more interest in total over the life of the loan, compared to if you were paying PI from the start. This is because you still need to pay back the lender the same amount of money (principal and interest) but have a shorter period to repay it.
For example, if you have a 3 year IO period on a 30 year mortgage, after the IO period of 3 years there are 27 years remaining to pay back the full loan (principal and interest) which means the repayments will be slightly higher after the IO period compared to if PI repayments were made from the start.
One tip we suggest to our clients with IO repayments is to set up an offset account, that way you are paying less interest each month and could use the funds to pay down the loan principal as well.
We often discuss the advantages and risks with the different repayment options with our clients, so speak to Skyward Financial today