Types of home loan payments
Two common types of home loan payments are principal & interest and interest only. The most popular by far is principal & interest so we’ll look at that first:
Principal & interest payments-
- As the name suggests each time you make a payment to your home loan part pays down the amount you owe that is the principal and part to interest.
- In the early years of your home loan, the majority of your payment is interest and a small portion is principal. That’s why your loan seems to go down very slowly in the early years of your home loan.
- At today’s interest rates interest will account for around 75% of your repayment and only 25% to reducing the loan.
- At 7% interest rate, the amount going to interest initially is around 88%. Your loan reduces even slower.
- That’s why it’s important to make extra repayments as this will reduce the amount of interest you pay. The amounts can be significant.
Interest Only payments-
- Interest only payments are mostly commonly used by property investors, though a portion of home owners use them as well.
- As the name suggests, your monthly payment is paying the interest only. No money is paid off the loan.
- It is vital that home owners know the consequences of having interest only payments with their home loan. Whilst the repayments are lower than principal & interest which can be attractive, be aware that nothing is being paid off the loan.
- Sometimes there are good reasons why you may want interest only payments on your home loan.
- You’re using an offset account to accumulate money to eventually pay off the loan.
- A future plan is to change your home to an investment property so this could be a useful strategy.
- You have other high interest debts you want to pay off in the short term.
Whichever payment type you choose, make sure you know how it works and the effect it has on paying off your home loan,….or not.
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