Description
This article addresses potential financial stress caused by the expiry of the interest-only period of IO loans. It uses a case study to explain how these loans work when managed well and then provides some options for borrowers who might not be able to meet increased repayments when the IO period ends.
Introduction
Just over four years ago Sarah bought an investment property. To help pay for it she took out a $........., 25-year mortgage that offered interest-only (IO) repayments for the first five years. At an interest rate of x% per annum those initial repayments amounted to $...... per month.
The benefit of IO was that it offered lower monthly loan repayments for five years, putting less strain on Sarah’s budget. However, with the IO period set to expire and the loan about to convert to principal and interest (P&I), Sarah now faces a significant jump in her monthly repayments. With 20 years remaining on the loan and at a steady x% interest she now needs to repay $,,,,,, per month, an increase of $..........
Sarah was well aware that this increase was coming, of course, and the higher payments were factored into her budget. Using an IO loan to kick off this investment worked out very well for Sarah.
Unfortunately, the same can’t be said for property investors who used the lower initial repayments on IO loans to borrow more money to buy more property, often at high loan-to-valuation ratios (LVR). After all, property was booming. What could possibly go wrong?
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