Worried about affording high mortgage repayments? Would you extend your loan term or choose interest-only repayments?

YIJU New Zealand has recently received messages from many readers concerned about steadily rising mortgage rates. In this period of high inflation, they fear facing the harsh reality that their income will no longer cover their mortgage repayments when their rate next changes. Many homeowners bought when house prices were high in recent years. As mortgage rates have soared this year, some believe extending their loan term could, in theory, make increasingly expensive repayments more affordable. Others suggest that borrowers unable to afford principal-and-interest repayments at high rates could apply to their bank for interest-only repayments, then return to principal-and-interest repayments once rates fall to low levels.

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To answer these two questions, let's first do the sums. Many commercial banks offer personal loan calculators on their websites, including ANZ, ASB and Westpac. These make it easy to calculate repayment costs at different interest rates and over different loan terms.

 

Take a NZ$500,000 mortgage at an annual interest rate of 6%. Over a 20-year term, monthly principal-and-interest repayments are NZ$3582. Extending the mortgage to 30 years reduces the monthly payment to NZ$2998. The monthly repayment clearly falls by NZ$584. This is mainly because extending the mortgage term by 10 years affects only the principal component of the repayments. The interest component remains unchanged.

 

Is extending the repayment term worthwhile for borrowers?

 

In the example above, reducing monthly repayments by NZ$584 certainly eases considerable pressure on the borrower. However, another important issue cannot be overlooked: the extra ten years of interest payable over a 30-year mortgage term. A 20-year mortgage incurs about NZ$360,000 in interest, assuming the annual rate remains at 6%. Over 30 years, interest on the same mortgage jumps to about NZ$580,000—an increase of NZ$220,000. This is the same property bought at the same price, yet adding ten years to the repayment term increases the interest cost by 61%.

 

Whether interest-only repayments are a good option depends on

the borrower's financial circumstances

 

Many borrowers have recently seen news reports about using interest-only repayments to ease mortgage pressure. YIJU believes borrowers should carefully consider their actual financial circumstances and discuss them with an experienced mortgage adviser before deciding. Choosing 5 years of interest-only repayments—the maximum generally offered by commercial banks is 5 years—may ease immediate pressure but create a serious financial burden over the remaining loan term. Below, we compare repayments under two arrangements: 30 years of principal-and-interest repayments, and 5 years of interest-only repayments followed by 25 years of principal-and-interest repayments.

 

Scenario 1: Again, take a NZ$500,000 loan at 6% over 30 years. Monthly principal-and-interest repayments are NZ$2998, with total interest over 30 years of NZ$579,193.

 

Scenario 2: For the same NZ$500,000 loan at 6%, a 25-year term requires monthly repayments of NZ$3222, with total interest over 25 years of NZ$466,451. At the same interest rate, choosing interest-only repayments for 5 years means monthly payments of NZ$2500, with total interest over 5 years of NZ$150,000. Total interest paid over the full 30 years is therefore NZ$466,451 + NZ$150,000 = NZ$616,451. During the remaining 25 years, monthly repayments will be about NZ$224 higher.

 

The benefits of interest-only repayments

 

For many buyers choosing house-and-land packages, interest-only repayments during construction can help with cash flow. Alternatively, if a borrower suddenly loses their job and no longer has a steady income, a bank may offer an interest-only period after assessing their ability to repay. For investment properties, the new rules mean owners of existing properties bought after 27 March can no longer deduct interest expenses from rental income for tax purposes. This has reduced investors' incentive to choose interest-only repayments to some extent. However, buyers purchasing new builds directly from developers can deduct interest against rental income, so an accountant may recommend interest-only repayments to help the owner maintain healthy cash flow.

 

Another situation involves borrowers seeking bridging finance between buying a new home and selling their existing one. If the existing home has sold unconditionally and the borrower needs to buy the new home before settlement, banks may offer interest-only repayments for a specified period to ease repayment pressure. Commercial property investments remain eligible for tax deductions under the new rules, so many investors also choose interest-only repayments. This is clearly related to cash flow: commercial loan terms generally do not exceed 15 years, requiring owners to make higher principal-and-interest repayments. An interest-only period of 5 years can therefore be helpful for investors' cash flow.

 

For borrowers, both extending the loan term and choosing interest-only repayments can be a double-edged sword. They may appear to solve repayment pressure in the short term, but can also be expensive decisions. So how do you choose the repayment arrangement that best suits you? The key may be to find a mortgage adviser with extensive market experience who can help you make the most appropriate plans and choices based on your actual financial circumstances.