Interest-Only Loans Explained

During the interest-only (IO) period your repayment covers only the interest charged that month. The amount you borrowed stays the same. At the end of the period, the loan normally reverts to principal and interest (P&I) for the rest of the term. Because there are now fewer years left to repay the full amount, the P&I repayment is higher than it would have been on a standard 30-year P&I loan.

Investors can often get IO periods of up to five years, and owner-occupiers usually shorter, depending on the lender. Extending an IO period means a fresh application and assessment.

Because you're not reducing the balance, your equity during an interest-only period comes only from any growth in the property's value and any money you hold in an offset account. If values are flat for a few years, you may finish the interest-only period with roughly the same debt and the same equity you started with.

The main reason is cash flow. Lower repayments mean more money stays in your pocket, which can make holding a property easier or help you build a buffer.

A second reason is debt priority. If you own your home and an investment property, interest on your home loan generally isn't tax deductible but interest on investment borrowing generally is. Some investors keep the investment loan on IO and direct spare cash to their home loan or offset account instead. The tax side depends on your circumstances, so speak with your accountant.

Interest-only rates are often higher than P&I rates. You aren't building equity through repayments, so your position depends more on the property growing in value. And the repayment jump when IO ends can be a real shock if you haven't planned for it.

Lenders also assess IO loans conservatively: they test your ability to repay P&I over the shorter remaining term, which can reduce borrowing capacity compared with a P&I loan.

There's also a behavioural risk. Lower repayments can feel like extra spending money. The strategy only works as intended if the cash flow saved is put to a purpose, such as reducing your home loan, building a buffer or funding the next step in your plan.

Put the expiry date in your calendar well ahead of time. Around six months before, review your options: let it revert to P&I, apply for a new IO period, or refinance to a different lender. If your circumstances have changed, such as a drop in income, a new IO period may be harder to get, so don't leave it to the last minute.

It's also worth modelling the P&I repayment in advance so you know exactly what the new figure will be. If the jump would be uncomfortable, starting small extra repayments or building savings in an offset account during the IO period can make the transition far easier.