If your priority is to reduce repayments in the short term, an interest-only loan could be worth considering. For a set period – typically up to 5 years for owner-occupied homes or up to 10 years for investment properties – you only pay the interest on your loan, not the principal.
This approach can significantly lower your monthly repayments during the interest-only period. However, there are important trade-offs to keep in mind:
- Higher Repayments Later
Once the interest-only period ends, your loan switches to principal-and-interest repayments. Because you now have a shorter timeframe to repay the principal, your monthly repayments will jump to a higher amount than if you had been paying principal from the start.
- Higher Overall Loan Cost
By delaying repayment of the principal, you extend the time your balance remains high. This means you’ll pay more interest over the life of the loan, increasing the total cost.
- Reduced Borrowing Capacity
Brokers and lenders must ensure you can afford repayments when your loan reverts to principal-and-interest. This means your borrowing capacity is assessed as if you’re repaying the loan over the remaining term:
- 5-year interest-only on a 30-year loan → repayments assessed over 25 years
- 10-year interest-only on a 30-year loan → repayments assessed over 20 years
Because the principal must be repaid faster, your maximum borrowing amount will be lower.
- Higher Interest Rates
Interest-only loans usually come with higher interest rates than comparable principal-and-interest loans. Investor loans are also typically priced higher than owner-occupied loans. Lenders may also apply different fees and charges depending on your loan type and circumstances.
The following table summarises these options and provides estimates of the impact current market interest rates would have on each option.
A principal and interest repayment loan for an OWNER-OCCUPIED property
A principal and interest repayment loan to an investor will typically have an interest rate about 0.25% higher than if it was for an owner-occupied property.
A principal and interest repayment loan for an INVESTMENT property
Note: These examples are based on a standard home loan with a loan to value ratio of less than 70% with a standard variable interest rate of 5.7%
The bottom line
Interest-only repayments can be a useful short-term tool to manage cash flow, but they:
- Lead to higher repayments later
- Increase your total interest costs
- Reduce your borrowing capacity
As rates and lending rules change, so do these calculations.
Working with a mortgage broker can make all the difference. We help you compare lenders, explore different loan structures, understand the trade-offs of different options and find the right product for you.
