Repayment Examples and Checklists
Interest only vs principal and interest: the repayment jump and the true cost
How interest-only home loans work in Australia, how much repayments jump when the interest-only period ends, the extra interest over the loan, and when interest only makes sense.
An interest-only (IO) home loan lets you pay only the interest for a set period, usually up to five years, after which the loan switches to principal and interest (P&I) over the remaining term. Your repayments are lower at first, but they jump sharply when the IO period ends, and you pay more interest over the life of the loan because the balance never falls during the IO years. On an illustrative $600,000 loan at 6.30%, five years of interest only costs $3,150 a month, then rises to about $3,977 a month, a jump of about 26%, and the loan costs about $45,000 more interest than paying P&I from the start at the same rate.
This guide is part of how to calculate home loan repayments. Rates are illustrative.
The arithmetic
Interest-only repayment:
$600,000 x 6.30% / 12 = $3,150.00
When the five-year IO period ends, the full $600,000 must be repaid over the remaining 25 years:
| Years 1 to 5 | Years 6 to 30 | Total interest | |
|---|---|---|---|
| Interest only for 5 years at 6.30% | $3,150.00 | $3,976.58 | about $781,974 |
| P&I from day one at 6.30% | $3,713.84 | $3,713.84 | about $736,981 |
| P&I from day one at 6.00% | $3,597.30 | $3,597.30 | about $695,029 |
How the IO total is built: five years of interest, $3,150 x 60 = $189,000, plus about $592,974 of interest over the 25-year P&I period, giving about $781,974.
Two points stand out:
- At the same rate, interest only costs about $45,000 more in total.
- Lenders usually charge a higher rate for interest only. If P&I would be 6.00%, the gap grows to about $87,000.
The repayment shock, and if rates rise
The jump from $3,150 to $3,976.58 is $826.58 a month. If rates have also risen by the time the IO period ends, say to 7.30%, the new P&I repayment is about $4,356.19, which is $1,206 a month more than the IO repayment. Put that number in your budget before choosing interest only, and use the rate rise stress test to see the range.
When interest only can make sense
| Situation | Why IO might fit | Conditions to check |
|---|---|---|
| Investment property | Interest on a loan used to buy an income-producing property is generally tax deductible, so some investors keep the deductible debt high and pay off their non-deductible home loan first | Get advice from a registered tax agent; IO rates are often higher |
| Short-term income drop | Parental leave, study or a career change for a known period | Plan the exit date; the lender will assess you for the remaining term |
| Construction | Many construction loans are interest only during the build, charged on the amount drawn | The loan converts to P&I after completion |
| Bridging finance | Buying before selling, with the old home sale clearing the debt | Strict time limits and capitalised interest on some products |
| Using an offset heavily | You keep surplus cash in an offset, effectively reducing interest while staying flexible | Requires discipline; you could get the same result on P&I |
Investor cash flow example
An investor with a $600,000 investment loan at 6.30% pays $3,150 a month interest only, against $3,713.84 on P&I over 30 years: about $564 a month of cash freed up. The strategy some investors use is to put that $564 into the offset on their own home loan, where interest is not deductible, rather than spend it. If that home loan is at 6.00%, every $564 saves interest at 6.00% with no tax, while the investment loan interest may be deductible. Whether this works for you depends on your tax position, the rate gap between IO and P&I, and the deductibility rules, so get advice from a registered tax agent. Spending the freed-up cash simply leaves you with more debt at the end of the IO period.
When to avoid it
- To afford a property you could not otherwise afford on P&I repayments. Lenders assess IO loans on the higher P&I repayment over the remaining term, so IO rarely increases borrowing power, and if it seems to, the property is probably a stretch.
- When you expect property values to stay flat. Without principal reduction, your LVR depends only on price growth.
- If you would struggle to refinance at the end of the IO period. Extending IO usually needs a new credit assessment, which you may not pass if your circumstances change.
Switching from interest only to P&I early
Most lenders let you switch to P&I at any time on a variable loan, often at a lower rate. Ask the lender to reprice the loan when you switch: the P&I owner-occupier rate is usually the lowest band. If the IO period is fixed, switching early may trigger break costs; see fixed rate break costs.
Checklist before choosing interest only
- Written reason for IO and an end date
- P&I repayment at the end of the IO period calculated, plus the same at a rate 2 points higher
- Rate difference between IO and P&I for your LVR and purpose
- Tax advice obtained if the loan is for investment
- Plan for what you will do with the money not spent on principal
- Expiry date in your calendar with a reminder six months ahead
Frequently asked questions
How long can an interest-only period last?
Commonly up to five years for owner-occupiers. Some lenders allow longer IO periods for investment loans. Policies vary and change.
Does interest only lower my borrowing power?
Usually not by much, because lenders assess the P&I repayment over the shorter remaining term plus the serviceability buffer.
Can I make extra repayments during interest only?
On variable IO loans, usually yes. Extra repayments reduce the balance and therefore the interest. Check whether the lender recalculates the IO repayment after each extra payment.
What happens if I cannot afford P&I when the IO period ends?
Contact your lender early. You can ask for a hardship variation, including a temporary extension of IO, under the National Credit Code. See mortgage hardship and AFCA complaints.
Sources
- ASIC Moneysmart — interest-only home loans
- Australian Taxation Office — rental property interest deductions
- APRA — lending standards for interest-only loans
