Quick answer: principal and interest (P&I) repayments pay the loan down from day one and cost less interest overall. Interest-only (IO) repayments are lower for a set period, usually up to five years, but the balance doesn’t fall, total interest is higher, and repayments jump when the IO period ends. IO mostly suits investors and short-term situations.
A worked example
A $600,000 investment loan over 30 years at 6.75%, comparing P&I from the start with five years interest-only. For simplicity both use the same rate, though IO rates are often higher.
| P&I throughout | 5 years IO, then P&I | |
|---|---|---|
| Monthly repayment, years 1–5 | ~$3,892 | ~$3,375 |
| Monthly repayment after year 5 | ~$3,892 | ~$4,145 |
| Total interest over 30 years | ~$801,000 | ~$846,000 |
Interest-only saves about $517 a month for five years, then costs about $253 a month more for the next 25, and around $45,000 more interest in total, before any difference in rate. Try your own numbers in our IO vs P&I calculator.
Who interest-only can suit
- Investors focused on cash flow, particularly while also paying down a home loan, where it often makes sense to pay down the non-deductible home debt first. Tax outcomes depend on your situation and the 2027 negative gearing and CGT changes, so check with your accountant.
- During construction, when construction loans are usually interest-only while the build is drawn down.
- Bridging finance while you sell one home and buy another. Bridging loans explained.
- A temporary squeeze, such as parental leave, where a short IO period with a clear end date can help. Ask early, because it needs lender approval.
Who P&I usually suits
Most owner-occupiers. Paying principal builds equity, reduces total interest and usually gets a lower rate. If you want flexibility, an offset account lets you keep savings working against the loan while still paying P&I.
Two things to know before choosing IO
- It can reduce your borrowing power. Lenders usually assess an IO loan on the higher P&I repayment over the shorter remaining term. How borrowing power is worked out.
- Plan for the jump. Diarise the end of the IO period. Extending it means a fresh application, and approval isn’t guaranteed.
Common questions
What is an interest-only home loan?
For a set period, usually up to five years, your repayments cover only the interest, so the loan balance doesn’t go down. After that, the loan switches to principal and interest over the remaining term, and repayments rise.
Are interest-only rates higher?
Usually, yes. Lenders often price interest-only loans higher than principal and interest loans, especially for owner-occupiers. Compare the actual rates for your situation.
Why do investors choose interest-only?
Lower repayments can help cash flow, and some investors prefer to keep extra money in an offset account instead. Tax treatment depends on your situation and the 2027 changes, so check with your accountant.
Does interest-only reduce how much I can borrow?
It can. Lenders typically assess an interest-only loan on the higher principal and interest repayment over the shorter remaining term, which can lower your borrowing power.
What happens when the interest-only period ends?
The loan switches to principal and interest over the remaining term, so repayments rise, often sharply. You can ask for another interest-only period, but it’s a new assessment and not guaranteed.
General information only, not financial, tax or credit advice. Example figures are estimates at a constant 6.75% with monthly repayments; actual IO and P&I rates, terms and lender policies vary.
