The two biggest components of your home loan repayments are typically the principal component and the interest component. You can take out a home loan with both principal and interest repayments, or interest-only home loans that include a period where you only pay the interest.
Depending on your situation, one of these types of loans may be more suitable than the other.
What is principal and what is interest?
The principal of your home loan is the amount of money you borrow from your bank or lender.
The interest is the cost charged by the bank or lender to you to borrow this money. The interest rate on your home loan, the loan term and the amount of your repayments will determine how much you end up paying back over the life of the loan.
Principal and interest home loans
A home loan with repayments of both principal and interest is one in which you pay interest and also repay part of the amount borrowed (principal) at the same time.
Your home loan will come with a specified term in which it is to be repaid – typically no longer than 30 years. The lender will usually work out the minimum principal and interest repayments needed to repay the loan within the selected term.
The benefit of a principal and interest home loan is that you may own your home outright sooner, since each time you pay the minimum repayment you’re chipping away at the principal loan amount while also covering the interest. And when it comes time to sell your property, you may have less outstanding balance to repay your lender compared to if you’d only paid to cover the interest.
Interest-only home loans
As the name suggests, you only have to pay the interest on this type of loan during the interest-only period. This means your payments over this time will be less than if you were also repaying the principal. However, the principal amount will remain the same – that is, your outstanding balance won’t be reduced – unless you choose to make extra repayments.
Interest-only home loans tend to be more popular with property investors than owner-occupiers. This is because investors are usually more focused on generating capital growth (equity) and a rental income from a property than buying the property outright.
The key benefit of an interest-only home loan is that the payments are lower than repaying the principal and interest combined.
One key consideration around interest-only home loans is that when it comes time to sell you’ll still have to pay back the full principal.
How much difference does the loan type make to your repayments?
You can use our home loan repayments calculator to estimate what the difference would be between a home loan with interest-only payments versus a loan with repayments of principal and interest. Set your terms and loan type to work out which option may suit you best.