5 min read | 8 Aug 2022 - updated 26 May 2023
Making your mortgage repayments as low as possible may seem like a no-brainer. And it can be a great short-term strategy to free up some cash flow – when life happens and it makes things tight, or if you’re an investor and this aligns with your property strategy and goals.
There are some things you need to know about Interest Only loans to make sure you’re going into this with eyes wide open. Over time, you will end up paying a bigger price if you get too comfortable paying interest only, and not paying off any principal on your loan term.
For a set length of time (usually 1-5 years), each repayment you make on an Interest Only loan only pays for the interest your lender is charging you to borrow from them. During this period, you don’t pay off the loan balance you borrowed, called the principal.
At the end of the interest-only period, your Interest Only loan automatically becomes a Principal & Interest loan. From that point on, your repayments will be paying off both the principal and the interest being charged on it. That means higher repayments than before, but you’ll be paying down your loan and making progress towards owning your home.
You borrow $560,000 at 4.2% over 25 years to buy an apartment and choose to pay Interest Only for the first 5 years.
Your monthly repayments would be $1,960.
But from the sixth year onward, where you’re paying both principal and interest, your monthly repayments would increase to $3,453 (which factors in that repayments for the original loan amounts are now being calculated over a 20-year period).
The early cost savings of an Interest Only loan are significant, and they can help to ease the financial pressure in the short term - but it comes at a price. In the above example, paying interest-only for the first 5 years ultimately costs you an additional $40,848 over the life of the loan compared to going Principal & Interest right from the start.
Try our handy Interest Only mortgage calculator to understand how Interest Only could reduce your repayments now.
Loan repayments are lower compared to Principal & Interest.
It may suit your financial situation better in the early stages of having a mortgage if you need more cash on hand for other things, and only for a short period of time.
Interest Only loans are good for negative gearing. The loan on an investment property is tax deductible debt, so investors often just pay interest-only so they can claim their repayments as interest tax deductions.
Lots of investors kick off with Interest Only loans. Their strategy is that, over the interest-only period, the value of their property will have increased to cover not just the principal they haven’t paid off but also the mortgage repayments they have paid.
If all goes according to their plan, they may end up with significant equity in their property without having paid a single cent off the loan principal.
They can then either sell up and pocket the profit or hold on and either go to P&I or try to get an extension on the interest-only loan period and bet their property continues to increase in value at similar rates.
The key downside you take on is not making progress towards paying off the amount you borrowed in the first place.
So, in the above example, after five years with an Interest Only loan, you’d still owe the original $560,000 debt even though you’ve made mortgage payments totalling $117,600 in that time. Other related risks you need to consider include:
Big picture, you’ll end up paying more over the life of the loan, so need to be able to afford that.
The interest rate might be higher compared to a Principal & Interest loan too.
After getting used to years of interest-only repayments, you may find the jump to Principal & Interest repayments high and unaffordable. Make sure you plan and budget ahead so you’re well prepared for the change.
If there’s a market downturn and your property hasn’t increased in value during the interest-only period, you won't have built up any equity. So, if you need to sell, you won’t have made gains from what you’ve paid out in repayments.
We offer both options to suit where you’re at. Make sure you understand that by choosing Interest Only, you can free up your cash flow when you need it, but it could cost more over the life of the loan. Do your sums before you commit and have a plan for when you switch to Principal & Interest.
Find out more about the differences between Principal & Interest and Interest Only loans.
We offer both Principal & Interest and Interest Only home loans for owner occupiers and investors on variable rates and fixed rates.
If the below criteria sounds like we’re talking about you, drop us a line:
You’re refinancing or buying an established property
You want to borrow up to but not more than 80% of the value of your property
At least one applicant is employed (PAYG) where you are employed by someone else
If you’re self-employed, you must have been trading for more than 2 years
Your property is in a capital city or major population centre
Your property is at least 50m² in living area excluding balconies and car space and the total land size is a maximum of 6 hectares
You’re an Aus/NZ citizen or permanent resident living in Aus
You have a good credit history
You have your own mobile and email
You’d be joining a lot of borrowers who choose to go tactical with an interest-free period for the first chapters of their homeownership story.
It makes those first few years less of a financial burden day to day, if you make sure not to end up getting stung with not much to show for what you’ve paid back at the other end.
Five years is the typical maximum interest-only loan period. After this period, the loan reverts to principal and interest repayments.
It completely depends on what your aims are at a given time. By going Interest Only, over the long term you will pay substantially more in total interest because you’ll have a larger debt for longer, and therefore building up equity in your home will be slower. And your repayments will jump once the Interest Only period ends, and you move onto Principal and Interest repayments, which you might find uncomfortable if you haven’t planned for them.
On the other hand, an Interest Only loan can be a highly effective way to lower your repayment obligations for a set period because that’s what suits you and your plan better at that time. And if you’re a property investor, repayments are tax deductible, which can make a big difference while you ride a strongly growing property market.
It depends on the situation; each one is evaluated individually. You should consider getting financial advice.
If you’d like to explore what going from P&I to IO for a year might look like, drop a line to email@example.com or text us on 0429 333 555, and we’ll walk you through it.
Absolutely – subject to the usual stuff like LVR, income, etc. Give us a call and let’s arrange a time for us to take a good look under the hood of your current loan type, put forward some refinancing options, bring those options to life with some examples and calculations, and help you decide what your next move might be, mortgage-wise.
For sure you can, with some vigorous number-crunching done upfront before anything gets set in stone. Going Interest Only is different to P&I, with its own upsides and downsides, so if you’d like us to take you through what the transition would be like, including how your repayments would go down but your equity would stay the same, let’s do it.
We’ll tell it to you like it is, and if you think it’s the right choice for you and the numbers stack up at our end, we’ll figure out a way with you to make the change happen.
Unlike most other lenders, Athena lets you make unlimited additional repayments on your Interest Only loan without being penalised for it. The extra repayments you make would be held in your redraw or offset account, reducing your loan balance and saving you interest. This means your Interest Only repayments would be less. When your selected Interest Only period ends, you’ll automatically switch to the principal and interest rate loan relevant to your LVR tier.
Take control of your finances and crush your debt faster! If your financial circumstances allow it, making additional repayments means you'll slash those pesky interest charges and save money in the long run.
A comparison rate takes into account both the interest rate and any added fees or charges related to the loan, so it’s important to consider this when comparing different loan options.