Interest-Only Loans — Fact Sheet
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This fact sheet is reproduced for general information purposes only.
It is an industry-standard explanatory document and has not been authored by Model Mortgages.
It does not provide personal advice.
Interest-only loans and repayment types
The repayment on your mortgage will always include the interest payable on the amount borrowed, no matter what kind of loan you have.
If you have a Principal & Interest (P&I) loan, part of your repayment reduces the balance of the loan.
With an Interest-Only (IO) loan, your repayments only cover the interest that is due and do not reduce the loan balance (the amount you borrowed).
As a result, an IO loan can only be obtained for a limited period, usually up to five years. At the end of the IO period, the loan will automatically convert to a P&I loan unless you apply to extend the IO period.
Who should use an interest-only loan?
Interest-only home loans are not designed for every type of borrower.
They are generally not recommended for owner-occupied home buyers, as paying down less of the principal usually results in paying more interest over the life of the loan. Repayments after the IO period are also likely to be higher, meaning there are usually limited benefits for owner-occupiers.
Interest-only loans can, however, be useful for property investors. This is because the interest on an investment property loan is usually tax deductible, subject to ATO rules. In this scenario, an IO loan can help investors structure their finances to support cash flow, tax planning, and investment strategy.
How do interest-only repayments differ?
If you start your loan with an IO period, your repayments will usually be lower initially. However:
- interest rates on IO loans are often higher than for P&I loans
- the loan balance does not reduce during the IO period
When the IO period ends, repayments increase to cover both principal and interest. This increase can be significant because the remaining loan term is shorter.
Because IO loans generally result in paying more interest over the life of the loan, they are usually only appropriate where there is a specific purpose, such as maximising tax efficiency for an investment property. They are not generally a good option solely to make repayments more affordable.
Even during an IO period, some borrowers may be able to reduce the principal by making voluntary extra repayments or using an offset account. The availability of these features varies between lenders, and additional fees may apply.
Benefits of interest-only loans
- Smaller repayments
- During the IO period, monthly repayments are lower than with a P&I loan.
- Improved cash flow
- Lower repayments may allow funds to be used for other purposes, such as paying off other debts, making additional investments, funding education, or purchasing another property.
- Tax benefits for property investors
- Interest on an investment property loan is usually tax deductible, subject to ATO rules. Owner-occupiers do not receive a tax deduction for interest on an IO loan.
- Flexibility over the IO term
- IO terms are often available for one, three, five, or sometimes up to ten years, which can be useful for financial and tax planning when structured appropriately.
Things to consider
- You may not build equity
- Because IO repayments do not reduce the principal, you may not build equity during the IO period. If property values fall, this may increase financial risk.
- Loan reverts to P&I
- Once the IO period ends, the loan automatically reverts to P&I unless an extension is approved. Borrowers should plan for higher repayments, refinancing, or selling the property.
- Limited features
- Not all lenders allow extra repayments during the IO period, and access to features such as offset accounts varies by lender and product.
- Higher total interest costs
- Loans with an IO period generally cost more in interest over the full loan term compared to loans with P&I repayments from the outset.
- Missed opportunity when rates are low
- Paying down principal while interest rates are low can reduce repayments and total interest when rates rise. An IO structure may delay this benefit.
Example
With a standard P&I loan of $500,000 at 4.78% p.a. over 25 years (80% LVR), the total interest paid would be approximately $357,766.
With the same loan and an IO period of 10 years, the total interest paid over the 25-year term would be approximately $440,443.
This represents an additional $82,676 in interest compared to a loan with P&I repayments for the full term.
Disclaimer
The information provided in this fact sheet is not legal, taxation, or financial planning advice.
It has been prepared without considering your objectives, financial situation, or needs.
All loan products are subject to lender criteria and approval. Fees, terms, and conditions apply.
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