Interest-Only vs Principal and Interest Loans

The repayment type you choose on your home loan affects your monthly outgoings, the equity you build, and the total amount of interest you pay over the life of the loan. Understanding the difference between interest-only and principal and interest repayments is an important part of choosing a loan structure that suits your situation.

This guide explains how each repayment type works, what the real cost differences are, and when each structure may be worth considering.

How Principal and Interest Repayments Work

A principal and interest (P&I) loan requires you to repay both the interest charged on your outstanding balance and a portion of the loan principal with each repayment. Over time, as your principal decreases, the interest component of each repayment also decreases — meaning more of each payment goes toward reducing the debt itself.

In the early years of a P&I loan, the majority of each repayment covers interest. As the loan matures and the balance reduces, the proportion going toward principal increases. This is how amortisation works — your repayment amount stays roughly the same (on a fixed rate) while the split between interest and principal shifts over time.

P&I repayments are the most common structure for Australian home loan borrowers. The key advantages are that you build equity from the start, your total interest cost is lower, and your loan balance is actively reducing throughout the term.

How Interest-Only Repayments Work

An interest-only (IO) loan requires you to pay only the interest charged on your outstanding balance for a set period — typically one to five years for owner-occupiers, and up to ten years for some investor loans, subject to lender policy. During this period, the principal does not reduce. Your loan balance at the end of the interest-only period will generally be the same as when you started, assuming you have not made additional repayments.

At the end of the interest-only period, the loan reverts to principal and interest repayments. At this point, the remaining principal must be repaid over the remaining loan term — which is now shorter than it was when the loan started. This means your P&I repayments after the interest-only period will usually be higher than they would have been if you had made P&I repayments from the beginning.

Interest-only loans can also carry higher interest rates than equivalent P&I loans. The difference varies by lender, product and borrower profile, so compare the actual rates and total costs rather than relying on a general rule of thumb.

The Real Cost of Interest-Only Repayments

While the lower initial repayments of an interest-only loan may appear attractive, it is important to understand the total cost over the life of the loan. Because you are not reducing the principal during the interest-only period, you continue paying interest on the full outstanding loan amount for that period.

Once the interest-only period ends, your repayments can increase because the remaining principal must now be repaid over a shorter period. This repayment shock can be significant if you have not planned for it in advance.

The total interest paid over the life of a loan will generally be higher on an interest-only structure than on a P&I loan of the same amount and term, all else being equal. The exact difference depends on the rates, fees, loan amount and repayment structure.

When Interest-Only May Be Worth Considering

Interest-only repayments are commonly used by property investors. For investors, the tax treatment of interest can be relevant, but deductibility depends on the purpose of the borrowing and the borrower's circumstances. Tax advice should be obtained from a qualified professional.

Interest-only structures may also be considered by borrowers managing short-term cash flow constraints — for example, during parental leave, a period of reduced income, or while carrying the costs of two properties during a transition. Some lenders also offer interest-only periods as a hardship measure for borrowers experiencing temporary financial difficulty.

Interest-only repayments are not generally the default choice for owner-occupiers purchasing a home to live in over the long term. The higher total cost and absence of principal reduction make it important to understand the trade-offs before choosing this structure.

Equity and Risk Considerations

A significant risk of interest-only repayments is that you build no equity through principal reduction during the IO period — unless the property increases in value or you make additional repayments. If property values fall during this time, you could find yourself with less equity than expected. This can reduce your options if you need to sell, refinance, or access equity.

By contrast, P&I repayments build equity from the first repayment. Over time, this growing equity position can give you more flexibility — to refinance on better terms, access equity for renovations or investment, or sell with a stronger net position.

Switching Between Repayment Types

Most lenders allow borrowers to switch between interest-only and principal and interest repayments during the life of the loan, subject to approval and eligibility requirements. If you are currently on an interest-only structure and approaching the end of your IO period, it is worth reviewing your options well in advance. The increase in repayments at the rollover point can be substantial, and planning for it early gives you more options — including refinancing to a better rate or a more suitable loan structure.

Check Your Borrowing Capacity

Use our borrowing capacity calculator to see what you may be able to borrow and compare the repayment impact of different loan structures.

Related guides: Fixed vs Variable Rate Loans, Split Loans and Offset Accounts Explained.