Interest only mortgage calculator & guide to interest only mortgages NZ

Interest-only mortgages are a temporary way to set up your loan. You only pay interest without paying back the mortgage.

Interest-only loans are popular and used primarily by property investors. They use it because it lowers your mortgage payments and improves cashflow.

But, while cheaper in the short term, over the long-term they are more expensive.

This is because (ironically) with an interest-only loan you pay more interest over time.

So, are they worth it?

In this article, you’ll learn why seasoned property investors like interest-only loans. And you’ll be able to use our Interest-Only Mortgage Calculator to see how one could work for you.

More from Opes Partners:

• Why do investors use interest-only loans? (Article)
• How long can I get an interest-only mortgage for? (Article)
• Case Study Sunday: Interest-only loans - When do they make sense for property investors (Podcast)

Interest only vs principal and interest – What’s the difference?

There are two types of mortgages: 

#1 – Principal and interest 

Most owner-occupiers use principal and interest (P+I) loans. 

Part of your repayment goes to paying back the loan (the principal).

The other part goes towards paying the interest on the loan. That’s the cost of borrowing money from the bank.

These mortgages typically start on a 30-year term. That means you have 30 years to pay the loan pack.

#2 – Interest-only 

An interest-only mortgage is as it sounds. You only pay interest on the loan. None of your repayment goes to paying the mortgage back.

Because you only pay interest, the size of your loan doesn’t go down. 

This means the total amount of interest you pay goes up in a straight line. And you end up paying more interest over time. 

With P+I mortgages your repayments are larger, but the interest you pay goes down as your debt goes down.

But that doesn’t mean interest-only loans don’t have their place. 

Here at Opes Partners, we often recommend that investors use these loans for as long as possible. In some cases, investors use an interest-only loan for up to 20 years and beyond.

Who can get an interest-only loan?

Generally, only property investors can get an interest-only loan.

In 2023, 34% of new lending to investors was interest-only, according to the Reserve Bank. That compares to 14% for owner-occupiers and first-home buyers.

You need to give the bank a reason for approving your interest-only application.

Often, this is as simple as saying: “It’s more tax-efficient to use an interest-only loan”. 

Your accountant can provide you a letter that explains that to the bank if necessary.

Banks are getting stricter with approving interest-only lending.

So, if you get turned away for an interest-only loan … it’s not the end of the world.

Sure, extra cash flow is great. But if it isn’t approved, you are still paying down debt, which improves your financial position.

In our experience, if you ask for it in the right way, you will likely get approved.

How much lower will my repayments be on an interest-only mortgage?

The amount you can temporarily save depends on the interest rate.

Here’s an example: Bill and Sam take out a $500,000 loan with a 7% interest rate.

If this was a 30-year principal and interest mortgage the weekly repayment would be $767.

But the bank approved this couple for an interest-only mortgage. So their weekly repayments is $673, saving $94 per week.

This means over the whole 5-year period, Bill and Barry will save $24,440 in repayments. 

This is money they would otherwise have paid towards their P+I mortgage. It’s a huge amount.

But over time the cost of an interest-only mortgage is still higher ... because you pay more in interest.

Let’s go through a few scenarios to see how the numbers work.

Bill and Sam pay less in interest on a P+I mortgage

What would happen if Bill and Sam paid down their loan over 30 years? They will pay $697,544 in interest.

Bill and Sam pay more in interest with a 5-year interest-only mortgage

If Bill and Sam get an interest-only mortgage for 5 years, after that it will turn into a P+I mortgage.

Under this scenario, they will pay $735,169 in interest. That’s $37,625 more than a 30-year P+I loan.

Bill and Sam pay even more in interest with a 10-year interest-only mortgage

If Bill and Sam extend the interest-only loan, they will get 10 years interest-only.

This then turns into a 20-year P+I mortgage at the end of that period. They’ll pay $780,359 in interest. That’s $82,815 more than a 30-year P+I loan.

Yes, Bill and Barry are making a large saving in the short term, but they will have to consider this in terms of what they want to achieve over the long term.

Can I borrow more money if I go on interest-only?

Many investors think they can borrow more on an interest-only mortgage.

That’s not true. Even though their costs are lower, investors can often borrow less on an interest-only loan.

Let’s say Jo and Jill apply for a $650,000 loan.

On a standard mortgage, the bank assesses their ability to make repayments over 30 years.

In this scenario, Jo and Jill will need to prove they can afford $5,200 monthly mortgage payments. That’s calculated using an 8.95% servicing test rate.

But if they choose an interest-only mortgage, these monthly repayments change.

Now, the bank is questioning whether the couple can manage the same loan over 25 years.

They then have to prove they can afford a monthly repayment of $5,432 for the interest-only loan.

How long can I get an interest-only loan for?

The phrase “interest-only mortgage” is a bit of a misnomer. It’s not an interest-only mortgage. It’s an interest-only period.

With most major banks, an interest-only period can only be approved for 5 years at a time (max).

But at the end of that period, you can apply to extend it.

Two things can happen at the end of your initial 5-year interest-only period.

1. You revert to paying principal and interest on your loan – that’s the default option
2. You 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 for up to 29 years.

But this gets difficult the more you do it. This is because the bank will test your income to see if you can afford to pay off the loan in the time you have left.

Let’s say, Jo and Jill get to the end of your first 5-year interest-only period, then apply for another.

Now, they have a 25-year loan.

So, the bank will test to see if the couple can manage to pay back the loan once the interest-only period ends. That means they must have enough money to pay the loan off over 20 years.

That means they need to have more money to show they can afford a higher repayment.

If they do the same thing 5 years later, they then need to prove they can pay off the loan in 15 years.

This starts to get tough from an income perspective. Your interest-only extension might not get approved.

What are the strategies to get around this?

One option is to apply to extend the mortgage term.

You can ask the bank: “Can I extend the mortgage back out to 30 years, so my 5-year period is tested over a longer time frame?”

This will keep your repayments lower.

At this point, it can be helpful to 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 15 years and beyond.

Interest-only vs Principal and interest. What’s the right choice for me?

It depends on your situation.

If you’re an older Kiwi investor, a principal and interest loan can be the right decision. Especially if you’ve already paid the mortgage on your own home.

This way you can start paying down your debt as you approach your retirement.

But for an early-to-mid career investor, an interest-only loan could help with cashflow.

That is particularly the case if you have a big mortgage on your own property.

Interest-only loans aren’t the right fit for everyone.

If you want to see if it’s the right option for you, have a chat with a mortgage broker such as Opes Mortgages.