Home Loans

Interest-only home loans

If you’re looking for cheaper home loan repayments for the first few years of your loan, an interest-only mortgage might be right for you.

What’s an interest-only home loan, you say? Well, in this article you’ll find everything you could ever need to know about interest-only home loans: How they work, how much they cost, how they compare to other types of home loans, and of course whether you should get one.

Compare interest-only home loan rates

Below is a snapshot of some of the lowest interest-only home loans. The home loan rates shown are based on a loan of $400,000 for a 30-year loan term, with an LVR (loan to value ratio) of 80%.

Lender
Advertised rate Comparison rate Monthly repayment Rate TypeOffsetRedrawOngoing FeeUpfront FeesLVRLump Sum RepaymentAdditional RepaymentsPre-approval

VariableMore details
REFINANCE IN MINUTES, NOT WEEKS

Nano Home Loans Variable Owner Occupied, Interest Only (Refinance Only)

  • Refinance only. Fast online application
  • No Nano fees. Free 100% offset sub account
  • Mobile app, Visa debit card & instant payments
REFINANCE IN MINUTES, NOT WEEKS

Nano Home Loans Variable Owner Occupied, Interest Only (Refinance Only)

  • Refinance only. Fast online application
  • No Nano fees. Free 100% offset sub account
  • Mobile app, Visa debit card & instant payments
VariableMore details
GET A DISCOUNTED GREEN RATE

Green Construction Home Loan (Interest Only)

  • Interest Only during construction
  • No monthly, annual or ongoing fees
  • Get Australia’s lowest rate construction loan when you go green
GET A DISCOUNTED GREEN RATE

Green Construction Home Loan (Interest Only)

  • Interest Only during construction
  • No monthly, annual or ongoing fees
  • Get Australia’s lowest rate construction loan when you go green
FixedMore details

Owner Occupier Fixed 3 year (Interest Only)

VariableMore details

Essentials Home Loan (Interest Only) (NSW and ACT only) (LVR < 90%)

VariableMore details
YOU COULD WIN $100k TO PAY DOWN YOUR LOAN*

Variable Home Loan (Interest Only) (LVR < 60%)

YOU COULD WIN $100k TO PAY DOWN YOUR LOAN*
VariableMore details

Simplicity PLUS Home Loan (Interest Only) (New Customer)

FixedMore details

Tailored Home Loan Fixed (Interest Only in Advance) 2 Years

FixedMore details

Owner Occupier Fixed 2 year (Interest Only)

FixedMore details

Your Way Plus Fixed Home Loan 4 year (Interest Only) (LVR 80%-90%)

Base criteria of: a $400,000 loan amount, variable, fixed, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 80%. However, the ‘Compare Home Loans’ table allows for calculations to made on variables as selected and input by the user. All products will list the LVR with the product and rate which are clearly published on the Product Provider’s web site. Monthly repayments, once the base criteria are altered by the user, will be based on the selected products’ advertised rates and determined by the loan amount, repayment type, loan term and LVR as input by the user/you. Rates correct as of October 26, 2021. View disclaimer.

On this page:

What is an interest-only home loan?

Interest-only (IO) loans are home loans that delay the repayment of the borrowed amount (the ‘principal’) for a fixed term, usually between three and five years. During this time, you only have to pay the interest on your loan, not the principal. At the end of that set period, the repayments transition to paying off the principal as well as the interest, to what is known as principal and interest (P&I) repayments.

An interest-only loan term is usually the same length as a standard home loan – around 30 years. However, instead of paying principal and interest for the full 30 years, you have the option to pay just interest for the first five years, for example, and then pay substantially more for the remaining 25 years.

Interest-only home loans could be summed up as ‘less now’ but ‘more later’ in terms of the monthly repayments one has to make across the term of the loan.

Interest-only home loans: A background

Interest-only home loans used to rival their principal and interest (P&I) repayment counterparts, accounting for around 40% of all outstanding mortgage balances in the mid-2010s. But that was before regulatory bodies introduced measures to slow down this form of lending. The Australian Prudential Regulation Authority (APRA) imposed a 30% restriction on the number of home loans issued by banks that could be interest-only in 2017.

Interest-only lending fell as a result. Since January 1 2019 those restrictions have been lifted, and institutions like ANZ and Westpac were quick to capitalise by loosening their lending criteria for interest-only loans. What’s more, major banks allowed customers to switch to interest-only loans instantly during the coronavirus crisis to help them manage their repayments.

interest only home loan
Source: Reserve Bank of Australia

And yet they haven't reached that 40% share of the market since. It’s hard to ascertain exactly what portion of mortgages they still are, but recent COVID-19 deferral data said interest-only loans were ‘overrepresented’ at 16% of the people unable to repay their mortgages. So it’s likely they are less common than that.

What interest rates do interest-only loans charge?

Much of this decline in the use of IO loans, aside from past regulation, is likely to do with these loans now having higher interest rates than they used to. According to Reserve Bank data, IO interest rates have fallen by 56 basis points on average for owner-occupiers since 2019’s first cash rate cut, but P&I rates have fallen by 77. These repayment types now have standard variable rates of 2.99% p.a and 3.79% p.a on average.

Loan purpose

Average interest rates (per annum) for ongoing loans

Average interest rates (per annum) for new loans

Owner-occupier

3.05%

2.54%

– Principal-and-interest

2.99%

2.48%

– Interest-only

3.79%

3.20%

Investment

3.40%

2.91%

– Principal-and-interest

3.29%

2.82%

– Interest-only

3.66%

3.07%

The table above shows the difference between the two in terms of interest rates. Source: RBA Lending Rates data.

Pros and cons of interest-only mortgages

The decision to take out an interest-only mortgage should only be made after carefully considering the benefits and risks involved. Some of these are outlined below.

Interest-only pros

  1. Lower repayments: The temporary lower repayments of an interest-only loan can free up money for other expenses like renovations or paying off other outstanding debts.

  2. Investment Strategy: Interest-only loans are great for investors who plan to profit by selling their properties within the IO period (eg. after making a capital gain) because it reduces their expenses (and relative cash outflows).

  3. Buying time: The reduced repayments effectively let people buy time through the delaying of higher repayments. Whether it be a temporary reduction of income (eg. someone taking 2 years off to study) or a temporary increase in expenses (eg. 2 years of higher school fees), if borrowers are confident of returning back to a level of income or expense ‘normality’ at the end of the interest-only term, then interest-only loans are a great way for them to effectively buy time and flexibility.

Interest-only cons

  1. Higher interest costs overall: Since you’re not paying off the principal over the interest-only period, you’ll end up paying more interest over the life of your loan than someone who has been paying both principal and interest over the entirety of theirs.

  2. Higher interest rates (generally): Interest-only loans often have a higher rate of interest than principal & interest (P&I) loans. This isn’t the case for all lenders though.

  3. Repayment shock upon expiry: If you’re not prepared, the expiry of an interest-only period can come as a shock as the costs of repayments suddenly increase. In 2018, APRA reported $360 billion worth of IO repayments that were set to ‘expire’ over the coming three years, but recent interest rate falls seem to have put a stop to that since.

  4. Less equity: By only paying the interest portion of your repayments, you’re possibly (subject to property value movements) not building any equity in your property. Many investors in recent times have built equity through rises in the value of their properties, but if the value falls, you could end up owing more to the lender than what the property could actually sell for if indeed you were forced to sell the property.

Source: Digital Finance Analytics, The Project

How long can you take out an interest-only loan for?

Interest-only periods usually last between three and five years. Some lenders offer interest-only periods of up to 10 to 15 years, but this may be restricted to investors. You may be able to negotiate the length of the interest-only period with your lender, depending on your personal circumstances.

What happens when interest-only loans expire?

When your interest-only loan period expires, your loan will roll over to principal and interest repayments. This means you’ll be paying off the outstanding mortgage as well as interest.

There are three main options you can pursue if your interest-only loan period is ending:

  • Extend the interest-only period: Lenders will want to keep their customers and may be willing to extend your interest-only period. This will probably be subject to a credit assessment and property valuation.
  • Refinance to another loan: If you’re nearing the end of your interest-only period, it might be a good idea to review your interest rate and finances before comparing other options in the market. Other lenders might be able to offer a better rate on a principal and interest loan than the rate of what your interest-only loan is rolling over to.
  • Ride out the expiry: If you’ve planned well and you’re confident that you’ll afford the P&I repayments (and you’re happy with your interest rate), riding out the expiry of the interest-only period and transitioning to the P&I stage of your current home loan is the most hassle-free option at your disposal.

Interest only vs principal & interest repayments

The key difference between principal and interest repayments (the more common choice by borrowers) and interest-only repayments is principal and interest loans pay off the actual loan principal right from the beginning. So the actual house you’ve borrowed all that money for is being slowly paid off, whereas interest-only loans only pay the extra interest costs.

Are interest-only loans more expensive or cheaper?

Desmond and Rachael have both found houses to buy and decided to take out separate loans of $400,000 for 30 years. Desmond chooses a P&I loan, while Rachael opts to pay interest-only for the first five years before switching to P&I for the remaining 25 years.

For the purposes of this comparison, it’s assumed both Desmond and Rachael have the same interest rate of 3.00% p.a which holds steady over the 30 years.

 

Loan amount

Monthly repayment during IO period

Monthly repayment after IO period

Total cost (principal & interest) of the loan

Desmond (P&I)

$400,000

N/A

$1,686

$607,109

Rachael (IO)

$400,000

$1,000

$1,897

$629,054

Total cost difference

N/A

N/A

+$211

+$21,945

As shown in the table above, by only paying interest for the first five years of the mortgage, Rachael’s loan will cost her almost $22,000 more than Desmond’s over the 30 years. You can use Savings.com.au’s Interest-Only Home Loan Calculator yourself to work out how much you might save short-term with an IO loan and how much more it’ll cost you in the end.

Interest-only home loans are popular with investors 

Interest-only loans can be a good short-term solution for property investors and owner-occupiers alike, but they're generally more suitable for investors. This is because investors can claim the interest portion of their loan as an investment expense on their tax returns. According to the ATO: 

“If you take out a loan to purchase a rental property, you can claim a deduction for the interest charged on the loan or a portion of the interest. However, the property must be rented out or genuinely available for rent in the income year you claim a deduction.”

That means investors can claim their entire repayments if they use an interest-only loan, making them a very affordable short-term option for building a portfolio. 

See also: How can property investors minimise tax?

However it’s important to remember that you will have to make principal repayments at some point down the track, regardless of the type of property. Interest-only loans tend to have more benefits for property investors, while owner-occupiers (outside of what might be described as extraordinary circumstances) are generally better suited towards a standard principal and interest loan. Do your research and read the terms and conditions before making a purchase decision.

Interest-only home loan frequently asked questions

1. Can you pay off an interest-only mortgage early?

Just as you can with a variable rate principal and interest mortgage, it is possible to pay off a variable rate interest-only mortgage early. This would typically involve either selling the house or making very large voluntary principal repayments.

2. How much deposit do I need for an interest-only mortgage?

Deposit requirements vary by lender, but like principal and interest mortgages, many lenders require a deposit of at least 5% of the property’s value. However, to qualify for some of the lowest rates and to avoid having to pay for LMI, you may need to have a deposit of at least 20%.

3. Can I get an interest-only mortgage with bad credit?

If you have bad credit, it will be more difficult to get any home loan, but it is possible. Here’s how to improve your chances of getting a home loan.

4. Can I switch to an interest-only mortgage from P&I?

Borrowers may apply to switch to interest-only payments from principal and interest, but this is subject to lender’s approval.

5. Can I pay a lump sum off an interest-only mortgage?

Many lenders allow variable rate interest-only borrowers to make lump sum repayments off the principal during the interest-only period, however, you may be required to fill out a form each time you want to do so.

6. Can I pay interest-only on a fixed mortgage?

Yes, there are many interest-only fixed-rate mortgages available. Fixed rate interest-only home loans are short-term home loan contracts that only require you to pay off the interest on the amount borrowed and pay at a fixed rate.

7. Is it worth overpaying an interest-only mortgage?

It’s only worth overpaying an interest-only mortgage if the excess funds go towards paying down the principal. As stated above, you’ll often have to inform your lender each time you wish to make a payment off the principal during an interest-only period.

8. Can I get an interest-only mortgage as a first time buyer?

Many lenders do offer interest-only mortgages to first home buyers, however, it’s important that first time buyers are fully aware of what interest-only loans are and how they work before applying for one.

9. Does interest-only mortgage affect credit rating?

Having an interest-only mortgage does not affect your credit rating any more than having a principal and interest mortgage.

Savings.com.au’s two cents

Interest-only loans can offer great opportunities to build cumulative wealth from buying and selling property in rising markets. The flip-side to this opportunity is the risk that lies in getting caught when the market turns and profits do not materialise (or disappear).

In this (unexpected) situation, interest-only loans can harm wealth through increased repayments after the interest-only period and/or having to sell the property at a net loss due to values falling and an inability to service new larger repayments.

Interest-only loans can be a great short-term solution for property investors and owner-occupiers alike, but they tend to have more benefits for property investors, while owner-occupiers (outside of what might be described as extraordinary circumstances) are generally better suited towards a standard principal and interest loan.

Do your research and read the terms and conditions before making a purchase decision.

Disclaimers

The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered which includes retail products from at least the big four banks, the top 10 customer-owned institutions and Australia’s larger non-banks:

  • The big four banks are: ANZ, CBA, NAB and Westpac
  • The top 10 customer-owned Institutions are the ten largest mutual banks, credit unions and building societies in Australia, ranked by assets under management in November 2020. They are (in descending order): Great Southern Bank, Newcastle Permanent, Heritage Bank, Peoples’ Choice Credit Union, Teachers Mutual Bank, Greater Bank, IMB Bank, Beyond Bank, Bank Australia and P&N Bank.
  • The larger non-bank lenders are those who (in 2020) has more than $9 billion in Australian funded loans and advances. These groups are: Resimac, Pepper, Liberty and Firstmac.
  • If you click on a product link and you are referred to a Product or Service Provider’s web page, it is highly likely that a commercial relationship exists between that Product or Service Provider and Savings.com.au

Some providers' products may not be available in all states. To be considered, the product and rate must be clearly published on the product provider's web site.

In the interests of full disclosure, Savings.com.au, Performance Drive and Loans.com.au are part of the Firstmac Group. To read about how Savings.com.au manages potential conflicts of interest, along with how we get paid, please click through onto the web site links.

*Comparison rate is based on a loan of $150,000 over a term of 25 years. Please note the comparison rate only applies to the examples given. Different loan amounts and terms will result in different comparison rates. Costs such as redraw fees and costs savings, such as fee waivers, are not included in the comparison rate but may influence the cost of the loan.