Interest-only vs Principal and Interest for Home Loans
Dominic Beattie
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- Principal and interest (P&I) and interest only (IO) are two options in making home loan repayments
- Paying 'principal and interest' means borrowers pay down a little of the amount borrowed - the principal - as well as the interest charged for borrowing it
- Making interest only repayments sees borrowers paying the interest charge only, but for a set period of time before the principal must also be repaid
Before we start, let's be clear on terminology. When it comes to loans, the 'principal' is the amount you've borrowed while 'interest' is what your lender charges you for borrowing it.
Regular home loan repayments generally cover your interest charge plus a partial repayment of the principal - unless you opt for interest-only payments.
Let's check how each works.
Principal and Interest repayments
For a home loan with principal and interest (P&I) repayments, you’ll be paying off a portion of your loan amount as well as the interest charged on it.
Your lender will charge interest on your loan based on an annual percentage rate. That rate is generally then divided by 365 to calculate the interest each day on the loan’s current balance.
Given interest is typically levied on a monthly basis, the daily interest charges for a month are added together to give a total which will be added to the loan balance.
Regardless of whether your principal and interest loan repayments are weekly, fortnightly or monthly, they'll be paying off interest as well as a portion of the loan balance.
As you gradually chip away at the loan amount, the amount of interest you pay should continue to decrease each month, provided your interest rate doesn’t change of course. The interest charged will also vary according to the number of days in the month.
Interest-only repayments
On the other hand, interest-only (IO) repayments require you to pay the interest portion of the loan only for a set period of time. Given you aren’t making payments to reduce the principal, the interest charged will remain much the same (unless you choose to make additional repayments or the interest rate changes).
See also: Interest-only (IO) Calculator
However, you’ll need to start paying off the principal once an interest-only period has ended. Despite interest-only repayments being lower during the interest-only period, you’ll actually end up paying more interest over the term of the loan.
Pros & cons: P&I or IO
Principal and interest
Pros
- You can borrow more: Lenders will typically allow you to borrow more of the property value (some up to 95%) if you pay P&I while IO loans are generally restricted to 80% of value
- Lower interest rates: P&I borrowers are considered lower-risk borrowers than those making IO repayments so the interest rate you'll be offered will also be lower
- Pay less interest: P&I borrowers will typically pay less interest over the term of the loan as they whittle down the principal that interest is calculated on
- Pay the loan off faster: As a P&I borrower, you'll typically pay off the loan faster, meaning you'll have unencumbered ownership of the property sooner
- Building equity faster: Because you're paying more off the principal, you'll see faster equity growth than someone just paying the interest charged
- No sudden repayment increase: P&I borrowers can avoid the shock of a steep jump in repayments at the end of an IO period
- Easier to refinance: It is generally much easier to refinance a P&I loan. It can also be difficult to extend an IO period, even with the same lender
Cons
- Higher repayments: Regular repayments are typically higher than they are during interest-only periods
- May not be the best option for some investors: A P&I loan may not be the most tax-effective option for some property investment strategies
See also: How is rental income taxed?
Interest only
Pros:
- Lower repayments: You’ll have lower mortgage repayments for a set period
- Provides a buffer: IO periods can help borrowers settle into a loan or provide relief during periods where cash flow may be tight, such as sickness or job loss
- Can put cash to other purposes: Minimising mortgage repayments can free up cash for investment in a business, shares and equities, or other opportunities
- Maximise investor cash flow: Making IO repayments can suit some investors who can claim tax benefits on interest expenses but not for repayment of the principal borrowed
See also: Investment home loan rates
Cons:
- Pay more interest overall: The principal borrowed will not fall during the IO period, meaning repayments will be higher once the period ends
- Pay a higher interest rate: Interest-only loans typically come with higher interest rates
How much higher are IO rates than P&I rates?
Reserve Bank data from March 2026 puts the IO loan rate at around 0.90% higher than for a regular P&I owner occupier home loan.
For investment home loans, the gap is narrower at less than 0.20%.
"Principal and interest loans help you build equity from the start, whereas interest-only loans can ease cash flow early on but you'll eventually need to start paying down the debt. Interest-only structures can also suit some property investors looking to maximise tax deductibility and free up cash for other investments, but they require a clear long-term repayment strategy."
What the expert says
Crunching the numbers: a case study
Kate is taking out a $650,000 loan for an investment property and is deciding between making P&I repayments for the entirety of the loan or IO repayments for the first five years.
If she makes P&I repayments straight up, her lender will offer her a lower interest rate.
Here's how the numbers stack up between the two options:
Investment loan | P&I | IO (5 years) |
Interest rate | 5.70% p.a. | 6.00% p.a. |
Monthly repayments | $3,773 | $3,250 (first 5 years) $4,188 (after first 5 years) |
Total interest payable over 30 years | $1,358,137 | $1,451,388 |
Additional interest paid with IO period: $93,251
Calculations based on Savings.com.au's Mortgage Repayment Calculator and Interest-Only Mortgage Calculator. The calculations assume Kate maintains the same higher IO interest rate for the entirety of the loan.
Savings.com.au's two cents
In recent data, APRA noted the majority of new home borrowers (around four in five) are on principal and interest repayment structures.
It also noted interest-only loans are more prevalent for investment loans.
Principal and interest and interest-only repayment schedules tend to shift according to the economic times and, specifically, the number of investors in the market.
If you are considering interest-only repayments to ease the cost burden of a home loan, it's essential you assess whether you'll be able to manage repayments when the interest-only period ends.
If you're unsure which repayment type to go for, it's wise to seek professional financial advice as to the best option for your circumstances and your short and long-term goals.
Which is better: principal and interest or interest-only?
Like many financial conundrums, there is no one simple answer to this question. It depends on your circumstances and needs at any given time.
Essentially, a principal and interest home loan will mean:
- you pay more upfront
- but over the life of the loan, you will typically pay less interest overall
On the other hand, interest-only home loans can see you:
- make lower repayments to start with
- but repayments can jump significantly when the IO period ends
Arguably, borrowers will know the end date of their IO period well in advance, giving them adequate time to prepare for higher loan repayments.
Who stands to benefit from IO loans?
IO loans may be able to assist:
- those with cash flow concerns over a shorter-term period
- investors looking to maximise cash flow and deductions on an investment property
- investors planning to hold a property for a short time only with the aim of making a quick capital gain and where there is no incentive to pay off any principal in the meantime
How long do interest-only periods extend?
Generally speaking, owner occupiers can make interest-only repayments for up to five years.
Some lenders will allow property investors to make interest-only repayments for up to 10 years.
How to know which interest-only timeframe to opt for
Assessing how long to make interest-only repayments may depend on:
- whether you are an owner-occupier or an investor
- how long you will be facing financial strain or other circumstances that may see you need to reduce your regular loan repayments for a period
- how much equity you have in your property
- your lender's individual policies
Finding an interest-only home loan
If you're in the market for an interest-only home loan, the table below features some of the most competitive interest rates on the market.
| Lender | Home Loan | Interest Rate | Comparison Rate* | Monthly Repayment | Repayment type | Rate Type | Offset | Redraw | Ongoing Fees | Upfront Fees | Max LVR | Lump Sum Repayment | Extra Repayments | Split Loan Option | Tags | Features | Link | Compare | Promoted Product | Disclosure |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
6.50% p.a. | 6.30% p.a. | $2,708 | Interest-only | Variable | $0 | $0 | 80% | |||||||||||||
6.58% p.a. | 6.42% p.a. | $2,742 | Interest-only | Variable | $10 | $450 | 60% | Disclosure | ||||||||||||
6.49% p.a. | 6.23% p.a. | $2,704 | Interest-only | Variable | $0 | $835 | 70% |
