When we are buying a property, we inevitable need to choose a mortgage and we are faced with so many different features. But the most common question you’ll be asked when setting up investment property finance is “do you want Interest-Only or Principal & Interest repayments?”.
For some of you this might well seem like such a basic question and be quite dismissive with your response, but trust me it’s not quite as simple as flipping a coin.
Let’s start off with some definitions:
- Principal is the money that was originally lent to a borrower.
- Interest is the cost of borrowing the principal.
- No matter the loan type, the interest on the loan is calculated on a daily basis on the outstanding amount of the principal.
With an Interest-Only mortgage, you pay only the interest charged on the loan as the name suggests. You do not pay down the principal debt at all.
Most lenders will only allow you to have an Interest-Only loan for a certain period of time, generally that’s up to 5 years. After that period has ended, your choices are for it to switch over to a Principal & Interest mortgage or depending on your circumstances and the lender, you can sign into another Interest-Only period.
Principal & Interest
A Principal & Interest mortgage, sometimes abbreviated to just P&I, means that your repayments have two portions, the ‘principal’ and the ‘interest’ component.
A portion of the repayment is used to pay off the interest amount due on your outstanding loan and the remaining is the principal portion, which slowly goes towards paying off the outstanding loan amount itself.
What should you pick?