Interest only mortgage calculator & guide to interest only mortgages NZ
This is the ultimate guide on how to get an interest-only mortgage in New Zealand.
Property investors love an interest-only loan.
A whopping 42% of investors who are taking out a new mortgage are taking out an interest-only loan, according to the Reserve Bank of NZ (May 2021 – April 2022).
But interest-only loans, while cheaper in the short term, are much more expensive over their lifetime.
This is because – ironically – borrowers who take out an interest-only loan end up paying more interest over time.
So, are these loans worth it?
In this article you’ll learn why seasoned property investors find interest-only loans so appealing and you’ll be able to use our Interest-Only Mortgage Calculator to see how one could work for you.
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What is an interest-only mortgage?
An interest-only mortgage is a temporary loan structure whereby the borrower only pays the interest on the loan and doesn’t pay any of the principal mortgage back.
Interest-only loans are popular with, and used primarily by, property investors to temporarily decrease the size of their mortgage repayments. This saves on costs and increases immediate cashflow.
However, over their lifetime, interest-only loans are more expensive than principal and interest loans (P+I).
This is because every payment you make on a principal loan decreases the amount left, which in turn means less interest. (More on this below).
This is not the case for interest-only loans.
But that doesn’t mean they don’t have their place. Here at Opes Partners we generally recommend that investors use interest-only loans for as long as possible, in some cases up to 20 years and beyond.
What’s the difference between an interest-only and a principal and interest loan?
In the big wide world there are two types of mortgages: principal and interest (P+I) and interest-only loan.
Principal and interest loans are most common with owner-occupiers and repayments are both the interest on the loan (the cost of borrowing money from the bank) and a portion of the actual money you loaned from the bank.
These mortgages are typically set to a 30-year term, and interest rates fluctuate depending on how long the borrower wants to fix the interest rate for.
As stated above, interest-only loans are a temporary loan structure where the borrower only pays the interest on the loan and doesn’t pay any of the principal mortgage back.
As ironic as it may sound, investors who take out interest-only loans do end up paying more interest over time.
Why? Because you are only paying interest; the size of your loan never decreases. This means the total amount of interest you pay goes up in a straight line.
But with a P+I loan you are continuously paying the debt down, which means you pay less interest as the size of your loan starts to decrease.
So, with principal and interest mortgages your repayments are larger, but the interest you pay is lower - as your debt goes down.
Who can get an interest only loan?
Generally speaking, only property investors get approved for substantial interest-only loans.
42% of new lending to investors was interest-only in the year to April 2022. That compares to 21% for owner-occupiers and first home buyers, according to the Reserve Bank.
A bank has to have a reason for approving an application for an interest-only loan.
Often this can be as simple as that it’s more tax efficient to use an interest-only loan, rather than go for principal and interest. Your accountant can provide you with a letter that explains that to the bank if necessary.
However, the banks are getting stricter with approving interest-only lending. So, if you do get turned away for an interest-only loan, you’re not alone, and it’s not the end of the world.
While it’s great for investors to have the extra cashflow, if it isn’t approved you are still paying down debt, which improves your financial position.
Anecdotally, the types of investors who are less likely to have interest-only lending approved tend to be investors, especially if they are nearing retirement.
Having said that, it’s still a popular choice amongst investors. Here at Opes most of our investors are on interest-only loans.
In our experience, if you ask for it in the right way, it is likely you will get it approved.
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Why use an interest-only loan?
While interest-only loans mean paying more interest to the bank over time, they can still be a good financial option for investors – especially if you already have a principal and interest mortgage hanging over your own home.
The reason for this is cashflow on the investment property.
If you buy an investment property and borrow all of the money from the bank, it is very unlikely that the rent from your tenant will cover all the expenses.
In fact, even on an interest-only loan the property will likely have negative cashflow, at least initially.
If you then start making principal repayments at the same time, the cashflow gets even worse.
Similarly, if you have an owner-occupier mortgage, it is generally better to pay this down first rather than paying back debt on your own home and your investment property at the same time.
In this case, the borrower will take the money they would have used to pay down their investment mortgage. They’ll then use that money to pay down their own personal debt more aggressively.
There are three main reasons for this:
1) It helps to protect your main home. If worst comes to worst you can always sell your investment property to pay back the mortgage, but you may not want to sell your main home if you get into a tricky financial situation.
2) It can help you grow your portfolio more quickly. Most investors borrow against their main home to fund the deposit for an investment property. This isn’t available for many investment properties, because they are highly leveraged. So paying down personal debt frees up useable equity, whereas paying investment debt may not.
3) It can help you save on tax. If the interest on your investment mortgage is still tax deductible, then your investment debt has a tax benefit, whereas your owner-occupier mortgage does not. That creates an incentive to pay back personal debt first.
The aim of the game is to pay down your debt on your owner-occupier. So, if you have one, make that your focus.
Can I borrow more if I go on interest-only?
It’s common for investors to initially think they’ll be able to borrow more on an interest-only mortgage, since their costs are lower.
This is not the case. An investor can often borrow slightly less than they could if taking out a standard P+I loan. Here’s why.
When you apply for an interest-only mortgage, you’re generally approved for a 30-year principal and interest mortgage with a 5-year interest-only period tacked on the front.
This means, at the end of that 5-year period, your loan will move to principal and interest by default.
So really, the phrase “interest-only mortgage” is a bit of a misnomer because it’s not an interest-only mortgage, it’s an interest-only period.
So, if you apply for a standard P+I mortgage the bank will test whether you can pay the loan back over 30 years.
But, if you apply to go interest-only, you will have 5 years’ interest-only repayments and then 25 years of principal and interest.
So, the bank is actually asking: “Will this lender be able to pay back the rest of their loan in 25 years if I grant them an interest-only loan for the first five years?”
To give an example, let’s say the bank is testing at 6.7%.
A $650K loan on P+I will require you to prove you can afford repayments of $4200 a month.
But the same loan on interest-only will be higher as it is now judged by whether you can afford the same loan over 25 years, which raises the repayments to $4470 a month. This means you’ll need to prove to the bank you have the income to afford this rise in repayments.
Long can I get an interest-only loan for?
With most of the major banks you can only get an interest-only period approved for 5 years at a time.
But at the end of that period you can apply to extend it. Let’s explain how it works, in the banks’ eyes.
Two things can happen at the end of your initial 5-year interest-only period. Either you revert to paying principal and interest on your loan – that’s the default option, or you can extend your interest-only period for another period (of up to 5 years).
Using this strategy you could theoretically keep extending the interest-only period.
But this gets difficult as you keep doing this, because the bank will test your income to see if you can afford to pay off the loan in the time you have left on it.
Let’s say you get to the end of your first 5-year interest-only period, and then apply for another.
The first time you applied you had a 30-year loan with a 5-year interest-only period. So you were tested on 25 years.
Next time you go back, you’ll have a 25-year loan. So when you apply for another 5-year interest-only period, the bank will see if you could afford the repayments on a P+I mortgage over 20 years, which means the tested repayments are now $4923 a month.
Do the same thing 5 years later, and you’ll be tested over 15 years.
This starts to get tough from an income perspective, so your interest-only extension might not get approved.
But that doesn’t mean you have to give up. There are other strategies you can use.
So, What are the strategies to get around this?
One option is to apply to extend the mortgage term.
So, when you apply for your second interest-only period, instead of applying for a 5-year interest-only period on a 25-year loan (tested on 20 years), you can ask: “Can I extend the mortgage back out to 30 years, so my 5-year period is tested on a 30-year loan?”
That means you’re now tested on your ability to pay back the loan over 25 years.
At this point it can be helpful to note you can also move between banks. So if one bank won’t approve your interest-only extension, perhaps another bank will.
Here at Opes we’ve seen some investors keep their interest-only loans for 5,10,15 years.
What about non-bank lenders?
Struggling to get an interest-only loan from the main banks? Some non-bank lenders have specific interest-only products for investors.
Resimac offers a 20-year interest-only product. That means an investor can have the certainty that they have their mortgage structure locked in for the long term.
There are some specific criteria you have to meet to qualify for this. For instance, the interest-only mortgage has a maximum of a 50% LVR (loan to value ratio).
That means if your house is worth $800,000, the maximum amount they’ll lend under a 20-year interest-only period is $400,000.
But in this case if your mortgage was $600,000, for example, you might put $400,000 on a long-term interest-only period, and the other $200,000 on P+I.
So that’s something to talk to your mortgage advisor about to see if it’s a good fit for you.
If you're looking for mortgage options outside the mainstream banks, here is a fair comparison between 5 commonly used non-bank lenders in New Zealand.
How much lower will my repayments be on an interest-only mortgage?
The amount you can temporarily save using an interest-only mortgage depends on the interest rate.
To give an example, let's say you take out a $500,000 loan. Now let’s say the interest rate on this loan is set at 4%, over a 30-year term.
If this was a standard principal and interest mortgage, then the weekly repayment would be $550.50.
However, if the loan was initially put on an interest-only mortgage, the weekly repayment would be $384.62, saving $143.12 per week.
So, if we look at this in terms of the 5-year lifespan of an interest-only period, this saving equates to $43,129.74. This is the sum that would otherwise have been spent paying off your P+I mortgage.
It’s a huge amount.
However, the overall cost of an interest-only mortgage is still higher than a P+I loan because you will face more interest costs.
For fun, let’s use the same example as above and compare scenarios of total interest costs.
You take out a $500,000 loan, and pay it down over 30-years at 4% interest. This incurs $358,778 in interest costs.
You take a 5-year interest-only mortgage, which turns into a 25-year P+I mortgage, which you then pay off over that time. This incurs $391,165 in interest costs. ($32,387 more than a 30-year P+I loan)
You take a 10-year interest-only mortgage, which turns into a 20-year P+I mortgage. This incurs $426,568 in interest cost. ($67,790 more than a 30-year P+I loan)
As you can see, any scenario of taking out an interest-only loan results in much higher interest costs. In these examples it’s a substantial $32,387 and $67,790 more for a 5 and 10-year period, respectively.
So, while you are making a large saving in the short term, an investor will have to consider this in terms of the overall balance of things.
What does a mortgage broker think?
Ella says the aim of the game is to pay down your debt on your owner-occupier. So, if you have one, make that your focus.
Investors utilise interest-only loans to increase cashflow, which can be spent to invest elsewhere.
But while you aren’t paying down debt, at least not immediately, the investor is relying on the premise the property is going to increase in capital gain. This historically has always been true over the long term.
So, What is the right choice for me?
Generally speaking, a switch to a principal and interest loan can be the right decision for older Kiwi investors, especially for those who have already paid off personal mortgages on their own homes.
This way you can start paying down your debt as you approach your retirement goals.
However, if you are an early-mid career investor and you have a sizeable mortgage on your own property, it could be a great idea to go for an interest-only loan on your investment properties.
Generally, this is what we see here at Opes, which is investors paying interest-only on their investments while paying down their personal mortgage first.
Interest-only loans aren’t the right fit for everyone. But if you think it might be an option you want to consider, have a chat with your mortgage broker.
Write your questions or thoughts in the comments section below.
Peter Norris, a certified mortgage adviser with 10+ years of experience, serves as the Managing Director at Opes Mortgages. Having facilitated over $1.2 billion in lending for 2000+ clients, Peter is a respected authority in property financing. He's a frequent writer for Informed Investor Magazine and Property Investor Magazine, while also being recognized as BNZ Mortgage Adviser of the Year in 2018 and listed among NZ Adviser's top advisers in 2022, showcasing his expertise.
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