There are 2 common types of loan repayment. Applying for a home loan will get you in choosing an option for these types of repayments. – Principal and Interest only or Interest-only.
It’s very important to know how things work on these different types of loan repayments and how they can change over time. Each of these repayment types has pros and cons on their respective conditions.
Before we differentiate the two, here’s the simple definition for ‘Principal’ and ‘Interest’
The principal is the amount you borrow while the Interest is the amount you’re charged by the lender for borrowing the principal amount.
Let’s begin with an Interest-only loan. For example, you had a $300,000 loan and you
paid 4% interest rates per month that would mean roughly that you paid about $1,000 in interest per month now that’s only the interest component of the loan you’re actually not paying anything off the loan itself and that’s where principal and interest comes in. So same scenario you’d be paying about $1,000 interest but you’d also be paying about $400 to $500 in principal so about $400 to $500 actually off the loan itself so the loan would reduce for that particular month from $300,000 to $299,500 and that’s how principal and interest loans works eventually your loan amount will decrease every month until it’s completely paid off.
To simplify, Principal and Interest repayments will require you to pay the principal off the top of the interest charged on it and Interest-only repayments will set you to pay the interest component of your loan for a given period of time.
Principal and Interest loan pros:
- Able to pay lesser interest through the total terms of the loan.
- Able to pay a lower interest rate compared to IO rates.
- Able to finish the loan faster to own the property sooner.
Principal and Interest cons:
- Repayments are higher than IO loan.
- Tax-efficient is not sure/guaranteed for an investment loan.
- Able to pay lesser repayments for a given period of time.
- A chance of having tax benefits for investment loans.
- No repayments on the principal amount during the Interest-only period.
- After the interest-only period, high repayments for the principal amount begins.
- The interest rates from the Interest-only period is higher than the P&I loan.
- You’ll be dealing more interest payable through the total terms of the loan.
Here’s what our Loan Processing expert takes on differentiating between Principal and Interest and Interest-only loans:
“P&I has flexible repayments and even though you’re paying a much higher amount, P&I had a much lower interest rate over IO loan…”
“IO only had a certainty of repayments and it has a higher risk compared to P&I.” – Emilyn Ronquillo, Loan Processing Assistant of Funding Force.