Interest-Only Or Principal And Interest: What’s The Difference?

An interest-only (IO) loan lets you pay the interest charged for an agreed period without being required to reduce the principal. A principal-and-interest (P&I) loan requires you to repay both the interest and part of the amount borrowed.

IO repayments are lower initially, but the principal generally remains unchanged and repayments can increase when the IO period finishes. P&I repayments start higher but reduce your debt from the beginning and usually result in less interest being paid over the full loan term, all else being equal.

For property investors, there is another consideration: lenders may assess an existing IO debt differently when calculating borrowing capacity for the next loan.

Interest-Only Vs Principal And Interest At A Glance

Comparison	Interest-Only	Principal & Interest
Initial required repayment	Lower	Higher
Principal reduces automatically	No	Yes
Short-term cash flow	Greater	Lower
What happens later?	Repayments usually rise when IO ends	P&I continues over the remaining term
Total interest, all else equal	Usually higher	Usually lower
Loan balance after several years	May remain largely unchanged	Gradually reduces
Future lender assessment	Can reflect the higher P&I repayment required over the remaining term	Based on the existing P&I structure and remaining term
May suit	Borrowers with a clear reason to preserve cash	Borrowers focused on reducing debt
Key consideration	What will you do with the extra cash flow?	Is reducing the mortgage sooner the priority?

Actual rates, eligibility and servicing treatment vary between lenders.

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Calculate Interest-Only Vs Principal And Interest Repayments

Try the IO or P&I calculator to work out the costs of just paying interest-only and whether it makes sense for your long term financial goals.

Bear in mind that the calculator only provides dollar figure savings when comparing interest-only loans to P&I repayments over a 30-year term.

Use the calculator to compare:

• Your repayment during the interest-only period
• The equivalent P&I repayment
• The repayment after interest-only finishes
• The total interest paid under each option
• How changing the length of the IO period affects the result.

Try more than one scenario.

For example, compare three- and five-year interest-only periods, then test what happens if the rate is higher when the IO period ends.

This gives you a more useful comparison than looking at the lower IO repayment on its own.

What Are The Benefits Of An Interest-Only Loan?

The main benefit of interest-only is additional cashflow flexibility.

Because you are not required to reduce the principal during the IO period, your minimum repayment is lower than an equivalent P&I repayment.

That can free up money for another purpose.

For a property investor, this might include keeping a larger cash reserve, covering property expenses, completing renovations or retaining funds for another deposit.

The lower repayment comes from postponing principal repayments. It is not the same as reducing your interest rate or eliminating part of the cost.

How useful IO is therefore depends partly on what happens to the cash you keep.

If an investor deliberately retains the difference for another deposit or a financial buffer, IO may support a wider investment strategy. If the difference is absorbed into normal spending, the borrower can arrive at the end of the IO period with much the same mortgage balance and a higher required repayment.

What Happens When The Interest-Only Period Ends?

The interest-only period forms part of the overall home-loan term.

If you have a 30-year mortgage with the first five years interest-only, you will generally have 25 years remaining to repay the principal when the IO period finishes.

This shorter repayment period is one reason the P&I repayment can rise noticeably.

For example, on a $600,000 loan at 6.00% p.a.:

• The five-year IO repayment would be about $3,000 a month
• P&I over 30 years would be about $3,597 a month
• After five years of IO, P&I over the remaining 25 years would be about $3,866 a month, assuming the rate had not changed.

The repayment after IO finishes deserves as much attention as the repayment at the beginning.

When assessing an IO structure, our brokers also consider whether the later P&I repayment is likely to remain manageable rather than assessing the loan solely on the lower initial repayment.

Worked Example: $600,000 Loan With Five Years Interest-Only

Consider a $600,000 loan with a 30-year total term.

Example assumptions: 6.00% p.a. interest rate throughout the loan, monthly repayments, five years interest-only followed by 25 years P&I, no fees, no offset balance and no additional repayments.

Scenario	Approx. Monthly Repayment
P&I from the beginning	$3,597
First five years on IO	$3,000
P&I after five years of IO	$3,866

During the first five years, IO leaves approximately $597 more per month available compared with starting on P&I.

But the loan balance remains about $600,000 after those five years if no principal has been repaid.

Using the assumptions above:

	P&I From Day One	5 Years IO, Then P&I
Total loan term	30 years	30 years
Approx. total interest	$695,029	$739,743
Approx. additional interest from IO	—	$44,713

The figures are illustrative and assume the rate remains unchanged for 30 years.

This is the trade-off behind interest-only: the borrower gets greater cash-flow flexibility upfront but has less time to repay the principal afterwards.

Whether that trade-off makes sense depends partly on what the extra cash allows the borrower to achieve during the IO period.

What Are The Benefits Of Principal And Interest?

With P&I repayments, you start reducing the amount borrowed from your first repayment.

This generally lowers the total interest paid over the life of the loan compared with paying interest-only for the first few years, assuming the same loan amount, interest rate, and overall term.

Reducing the principal can also build equity through repayments rather than leaving changes in equity dependent mainly on property values.

You also avoid the scheduled switch from IO to a higher P&I repayment.

Rates can differ between IO and P&I products. The actual difference depends on the lender, loan purpose, LVR and product available at the time, so compare the loans available to you rather than assuming IO will always carry a particular rate premium.

Does Interest-Only Affect Borrowing Power?

It can.

The repayment you make each month is not necessarily the repayment a lender uses when assessing your borrowing capacity.

For an IO mortgage, a lender may take into account the P&I repayments required after the IO period finishes and the shorter period remaining to repay the principal.

Consider a 30-year loan with five years interest-only.

The borrower may currently be paying the lower IO amount, but the principal still needs to be repaid over the remaining 25 years. When that borrower applies for another loan, the lender’s servicing calculation may reflect that higher future repayment.

This helps explain why an investor can have comfortable monthly cash flow but receive a borrowing-capacity figure that is lower than expected.

Different lenders can also assess existing debts differently.

Broker Insight: Think About The Next Loan As Well

For an investor planning another property purchase, our brokers consider more than the repayment on the current loan.

They also look at how much borrowing capacity may remain after settlement and how the existing debt is likely to be assessed when the investor applies again.

This becomes more important as a portfolio grows.

A structure that provides useful cash flow on the first investment can become restrictive later if the existing debt uses more servicing capacity than expected.

Is Interest-Only Better For An Investment Property?

Interest-only can be useful for an investment property when preserving cash serves a clear purpose.

An investor planning another purchase may want to keep funds available for a future deposit, property expenses or an emergency buffer.

An investor who is no longer expanding their portfolio may prefer to start reducing the existing debt instead.

Future borrowing plans can also change the calculation.

If you expect to buy again, the servicing treatment of the existing IO loan may matter alongside the interest rate and monthly repayment.

For that reason, choosing between IO and P&I for an investment property usually involves comparing:

• Immediate cash flow
• Total interest cost
• The repayment after IO finishes
• Future borrowing capacity
• What you intend to do with the cash retained during the IO period.

There is no single repayment type that suits every property investor.

Can Interest-Only Affect Refinancing?

Yes.

A new lender will reassess your circumstances when you refinance, including your income, expenses, liabilities, credit history, loan balance and property.

If you have spent several years making minimum IO repayments, the principal may not have reduced substantially.

Your equity position will also depend on what has happened to the property’s value.

For example, if the loan balance remains largely unchanged while the property value falls, your LVR increases. That can reduce the refinancing options available.

This matters if your strategy assumes you will refinance into another IO period later.

Another IO period is not guaranteed. Eligibility will depend on your circumstances and lender policy at the time.

Can You Switch From Interest-Only To Principal And Interest?

Often, yes.

The process depends on your lender and loan product.

If you are considering switching early, check:

• Your new repayment
• Whether your rate changes
• How much of the remaining loan term is available
• Restrictions applying to any fixed-rate component
• Whether another lender offers a more suitable structure.

Starting P&I earlier generally means reducing the principal sooner.

Can You Extend An Interest-Only Period?

Possibly.

An IO extension usually requires approval under the lender’s policy at the time.

Your lender may reassess your income, expenses, existing debts, repayment history and property position. Limits can also apply to how long a loan is allowed to remain interest-only.

If your current lender will not extend the IO period, refinancing may be another option if you qualify and the cost of changing lenders makes sense.

It is worth reviewing this before the IO expiry date rather than waiting until your repayments have already increased.

What About Interest-Only Loans And Tax Deductions?

Choosing interest-only does not by itself determine whether the interest is tax-deductible.

For a rental property, the tax treatment generally depends on what the borrowed money was used for and whether the relevant tax requirements are met.

The principal portion of a P&I repayment is not interest.

This becomes particularly important when borrowed funds have been redrawn, refinanced or used for both investment and private purposes.

A mortgage broker can help with the lending structure. For advice about deductibility or your tax position, speak with a registered tax professional.

Can You Make Extra Repayments On An Interest-Only Loan?

Often, yes, although the rules depend on the loan.

Some borrowers choose IO for the lower required repayment but make additional principal repayments when they have surplus cash.

Variable-rate loans tend to offer more flexibility for extra repayments, while fixed-rate loans can have restrictions or costs.

If access to the money is important, you may also want to compare making extra repayments with keeping cash in an offset account where the product offers one.

Interest-Only Vs P&I: Which One Should You Choose?

IO and P&I solve different problems.

IO provides lower required repayments for a period and can preserve cash for other purposes.

P&I starts reducing your debt immediately and will generally result in less interest over the full loan term, assuming other loan terms are the same.

For investors, future borrowing plans can be just as important as today’s repayment.

Before deciding, compare the repayment now, the repayment after IO finishes, the total cost and how the structure fits with what you plan to do next.

Choosing between IO and P&I involves more than comparing two monthly repayments.

Home Loan Experts can help you compare the cost and cash-flow implications, understand what happens when an IO period finishes and consider how the structure could affect your plans to borrow again.

Please call us on 1300 889 743 or enquire online and one of our commercial mortgage brokers will get back to you with some options.