Interest-only home loans: 4 things to think about before you choose one

Interest-only repayments can ease cash flow for property investors, but the loan balance doesn't fall and repayments rise when the period ends. Here's how it works.

An interest-only home loan lets you pay only the interest for a set period, usually one to five years, so repayments are lower but the loan balance doesn’t fall. Interest-only loans suit some property investors. Before you choose one, check how the period ends, how much more interest you’ll pay and how lenders will assess you.

With the cash rate tipped to rise, property investors are paying more attention to interest-only loans as a way to manage cash flow while rates remain elevated. The Reserve Bank held the cash rate at 4.35% at its August meeting, and its minutes noted that demand for new housing loans had declined significantly, particularly from investors.

Interest-only lending is a specific product with some advantages in certain situations and risks in others. Four points will help you decide whether it is the right structure for you.

1. How interest-only repayments work

On a standard principal and interest loan, each repayment reduces the outstanding loan balance while also covering the interest charged for that period. On an interest-only loan, repayments cover only the interest.

The principal balance does not get paid down during the interest-only period, which means the loan balance at the end of year five, for example, is the same as it was at the start. This keeps monthly repayments lower during the interest-only period but leaves the full principal to be repaid once that period ends.

Two features can change that picture. An offset account linked to a variable interest-only loan reduces the balance the lender charges interest on, and extra repayments reduce the balance itself. Not every interest-only product offers both, so check the features as well as the rate.

For a closer look at the trade-off for owner-occupiers, see whether to choose principal and interest from day one.

2. Who interest-only loans tend to suit

Interest-only loans are most commonly used by property investors. Where the loan interest is tax-deductible, keeping repayments as interest-only maximises the deductible portion of each payment. Investors may also prefer to direct surplus cash toward other investments, or to an offset account against their non-deductible home loan, rather than reducing a debt that is working in their favour from a tax perspective.

The tax picture has shifted for some investors. Under the negative gearing changes announced in the May 2026 Federal Budget and passed by Parliament on 25 June 2026, from 1 July 2027 rental losses on established residential properties bought after 7:30pm AEST on 12 May 2026 can only be offset against residential property income rather than salary or wages, with unused losses carried forward. Our summary of the 2026 negative gearing changes covers the detail. Properties held or under contract before that time keep the existing rules, and new builds aren’t affected. If you’re weighing interest-only repayments for a tax reason, ask your accountant how these changes apply to you before you commit.

For owner-occupiers, interest-only loans are less common and typically used in specific circumstances, such as a short period of parental leave, a planned sale or a bridging situation. Lenders assess these applications more conservatively, and the rationale needs to be clear.

3. What happens when the interest-only period ends?

Interest-only periods are fixed in duration, typically between one and five years for investors and up to five years for owner-occupiers, subject to lender policy. When the period ends, the loan reverts to principal and interest repayments calculated over the remaining loan term.

Because no principal has been repaid, the remaining loan term is shorter relative to the full balance, which pushes repayments up when the loan converts. On a $600,000 loan with a five-year interest-only period, the full balance remains to be repaid over the remaining 25 years. Planning for that repayment increase well in advance is important.

At an illustrative rate of 6.50% p.a. on a 30-year loan, the numbers look like this:

In this example, repayments rise by about $800 a month when the interest-only period ends, and you pay roughly $45,000 more in interest across the loan. This example is for illustration only. It assumes the same interest rate for the full 30 years and for both structures, and excludes fees and charges. Interest-only rates are typically higher, so the real difference is often larger. It is not a quote or an offer of credit.

When the period ends you can let the loan revert, ask your lender to extend the interest-only term, or refinance to another lender. An extension or refinance is a fresh credit assessment, so approval isn’t automatic. Start the conversation three to six months before the end date.

4. How lenders assess interest-only applications differently

Lenders apply stricter serviceability tests to interest-only loans than to principal and interest loans. Because the borrower will eventually need to repay the full principal over a shorter remaining term, lenders typically assess the borrower’s capacity to service the loan on principal and interest terms from the outset, even during the interest-only period. This can reduce the amount a borrower is able to access compared to a standard principal and interest structure.

Lenders also add a serviceability buffer on top of the actual interest rate, and APRA limits on high debt-to-income lending now apply across the banking sector. Our article on APRA’s debt-to-income limits explains what that means for investors with several loans.

Not all lenders offer interest-only terms to all borrower types, and the rate is typically slightly higher than an equivalent principal and interest loan. Factor that into any comparison, and look at the comparison rate as well as the headline rate.

Is an interest-only loan right for you?

An interest-only structure can make sense if you’re an investor with a clear tax and cash flow strategy, a plan for the repayment increase, and a lender whose policy fits your situation. It is harder to justify if lower repayments are the only way the loan looks affordable.

Before you decide, read up on the key risk factors lenders assess for investment property finance and on fixed vs variable rates, because the two decisions often go together. A broker can compare investment property loans from lenders who offer interest-only products and model the repayment change for your loan size. Attain Loans is a mortgage broker in Melbourne’s west that can run those numbers across its lender panel, subject to each lender’s assessment.

This article is general information only and doesn’t take into account your objectives, financial situation or needs. Consider whether it’s appropriate for you and speak with a licensed professional, including your accountant, before making a decision.

Further questions

This is general information only and is subject to change at any given time. Your complete financial situation will need to be assessed before acceptance of any proposal or product.