Lately, the number of people taking out interest only home loans has been on the rise. With the normal loans you are paying off the interest and a small part of the principal every month. As you are repaying a small part of the loan every month, you are building equity in your home. This way at the end of the loan term you would have paid of the entire loan on your home.

Originally interest only loans were used mainly to finance investment properties. The huge attraction of these types of loans for financing your investment property is the tax advantage called ‘negative gearing’ - i.e. you can basically claim your entire interest payment as a tax deduction - this is only for investment properties though. In a booming property market, financing investment properties this way makes huge sense. After a few years if you sell your property, you make a huge capital gain…You can clear off the loan and the balance becomes your profit. All through the life of loan, you get huge tax deductions through negative gearing. So you win both ways.

These days though a lot of owner occupied homes are being financed by interest only loans. Rising property prices and rising living costs are the two main reasons for the increase in these types of loans. By opting for an interest only loan, you can pay less monthly repayments than with a standard loan. So that can be huge plus for people struggling to pay their bills.

Another psychology at play here is that by opting for these types of loans, for the same amount of monthly repayment you can borrow more money - example…say you can afford to pay 2000 dollars per month…With a principal and interest loan assume that bank only gives you could 250,000 dollars. But for a 2000 dollar monthly repayment, if you opt for an interest only loan, the bank might lend you up to 350,000 dollars. So basically you can get more loan amount with interest only loans.

Interest only loans can be very risky for a owner occupied home. You are basically not paying any principal..So you are not owning any equity in your home. You are also not getting any tax deduction because it is a owner occupied house. In times of falling property prices, you could be forced to sell your house for a loss if the sale price is less than the principal still owing on the loan. This is called negative equity.

Buy only the property you can afford. Don’t opt for interest only loans just so that you can save some money on monthly repayments…Be wary of the risks involved.

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