Interest Only Mortgages in New Zealand — Pros and Cons

Interest Only Mortgages in New Zealand — Pros and Cons

An interest only mortgage lets you pay just the interest on your loan each month, rather than paying down the principal. This means your repayments are lower, but the loan balance doesn't shrink. In New Zealand, these loans are typically offered by major banks like ANZ, ASB, BNZ, and Westpac, as well as some non-bank lenders.

Interest only mortgages are not for everyone. They suit specific situations and come with both benefits and risks. This guide explains how they work, who they're for, and what to watch out for.

How Interest Only Mortgages Work in NZ

With a standard mortgage, your repayments cover both interest and a portion of the loan principal. With an interest only mortgage, you only pay the interest. The principal remains unchanged.

Most NZ lenders allow interest only periods of 1 to 5 years. After that, the loan converts to principal and interest repayments. You can usually negotiate a new interest only period, but this depends on your lender and circumstances.

Interest only loans are available for both owner-occupied homes and investment properties. However, terms and conditions vary.

Key Features of Interest Only Mortgages

• Lower repayments: Monthly payments are significantly lower because you're not paying off the principal.
• Fixed or floating rates: You can choose a fixed rate for certainty or a floating rate for flexibility.
• Limited term: Interest only periods typically last 1–5 years, after which you must switch to principal and interest.
• No principal reduction: Your loan balance stays the same unless you make extra payments.
• Higher long-term cost: Because you're not reducing the principal, you pay more interest over the life of the loan.

Pros of Interest Only Mortgages

• Improved cash flow: Lower repayments free up money for other uses, such as investing, renovations, or managing unexpected expenses.
• Tax advantages for investors: Interest payments on investment properties are generally tax-deductible. An interest only structure can maximise this benefit. Check with Inland Revenue for current rules.
• Short-term flexibility: Useful if you're between jobs, on parental leave, or have irregular income.
• Potential for capital growth: If property values rise, you could build equity without paying down the principal.
• Easier to manage multiple properties: Investors often use interest only loans to keep repayments low across a portfolio.

Cons of Interest Only Mortgages

• No equity building: You don't reduce your loan balance, so you won't build equity through repayments.
• Higher total interest cost: Over the full loan term, you'll pay more interest because the principal stays high for longer.
• Risk of negative equity: If property values fall, you could owe more than the property is worth.
• Stricter lending criteria: Lenders may require a higher deposit (often 30% or more) and a strong income.
• Potential for repayment shock: When the interest only period ends, repayments can jump significantly.
• Limited availability: Some lenders restrict interest only loans to investment properties or high-equity borrowers.

Who Is an Interest Only Mortgage For?

Interest only mortgages suit certain borrowers:

• Property investors: They can maximise tax deductions and keep cash flow low while holding multiple properties.
• Borrowers with variable income: Self-employed people or contractors may benefit from lower repayments during lean months.
• Those expecting a lump sum: If you plan to sell another property or receive an inheritance, you can pay down the principal later.
• Short-term homeowners: If you plan to sell within a few years, lower repayments may make sense.

However, they are generally not recommended for first-home buyers or anyone who struggles to save. Without disciplined repayments, you risk being stuck with a large debt indefinitely.

Fees and Costs to Watch For

Interest only mortgages come with the same fees as standard mortgages, plus some extras:

Always ask your lender for a full breakdown of fees before committing. Check the lender's disclosure statement for details.

How to Apply for an Interest Only Mortgage

Follow these steps if you're considering an interest only mortgage:

1. Assess your situation: Determine why you want an interest only loan. Are you an investor? Do you need short-term cash flow relief? Be clear on your goals.
2. Check your equity: Most lenders require at least 30% equity (a 70% loan-to-value ratio) for interest only loans. Some may accept 20% for investment properties.
3. Compare lenders: Shop around. Major banks like ANZ, ASB, BNZ, and Westpac all offer interest only options, but terms and rates differ. Non-bank lenders may have more flexible criteria.
4. Get pre-approved: Submit an application with your income, expenses, and property details. The lender will assess your ability to repay both now and when the interest only period ends.
5. Read the fine print: Understand the interest only period length, conversion terms, and any penalties for early repayment.
6. Plan for the future: Have a strategy for when the interest only period ends. Will you sell the property, refinance, or switch to principal and interest?

Tips for Using an Interest Only Mortgage Wisely

• Make extra payments if you can: Some lenders allow you to pay extra towards the principal without penalty. This reduces your loan balance and future interest.
• Use a revolving credit facility: If you have extra cash, park it in a revolving credit account linked to your mortgage. This reduces your interest costs while keeping funds accessible.
• Set a reminder: Note when your interest only period ends. Repayments can double or triple, so prepare well in advance.
• Consider your tax position: For investment properties, interest is deductible. But tax rules change — check with a tax advisor or Inland Revenue.
• Don't rely on capital gains: Property prices can fall. If you're not paying down the principal, you could end up in negative equity.

Verdict

Interest only mortgages can be a useful tool for property investors and borrowers with specific short-term needs. They offer lower repayments and tax advantages, but they come with higher long-term costs and risks.

For most homeowners, a standard principal and interest mortgage is a safer choice. If you're considering interest only, make sure you have a clear exit plan and understand the potential for repayment shock.