The main difference between interest-only (IO) and principal-and-interest (P&I) loans is how the repayments are structured. With an interest-only loan, you pay only the interest for a set period, which keeps repayments low but doesn’t reduce the loan balance. This can be useful for investors or for short-term financial flexibility.
In contrast, P&I repayments include both interest and principal, helping gradually reduce the loan balance and leading to lower total interest paid over time.
The right choice depends on your financial goals and circumstances.
The pros of interest only loans
- New home buffer: You can choose interest only for a year in order to buy furniture or to renovate your new home.
- Property investment: You can maximise your cash flow position and reduce your opportunity cost, although it depends on whether your long term goal is to have a positively-geared portfolio.
- Business investment: You can leverage funds that aren’t tied up in your property to invest in your business
- Buying shares and equities: Using a residential property to secure your shares is acceptable to some banks and a short-term IO period can give you a bit more leg room to continue growing your portfolio.
- Turning a home into an investment: Save thousands in mortgage repayments if your plan is to switch your home to be an investment property.
- Buying a new home before selling the old one: A short-term IO will reduce your home loan repayments on a new property purchase so you can focus on paying down your old mortgage and maximise your equity growth.
- Retirement planning: With the right exit strategy in place, you can drastically reduce your mortgage repayments when downsizing for your autumn years.
- Covering a temporary shortfall in income: Having a baby, relocating overseas or switching to part-time work are very common life events and a short-term IO period can help manage the fall in your normal income.
Check out the interest only loan page to discover if you qualify!
Alternatively, call us on 1300 889 743 or complete our free online assessment form to speak with one of our specialist mortgage brokers.
What are the benefits of paying principal and interest (P&I)?
The biggest drawback of interest only by far is the cost!
By paying P&I, you’re paying off the mortgage earlier in the term so you end up paying less in interest.
For example, a $500,000 loan with an interest rate of 4.00% p.a. over 30 years will cost $32,408 more in interest if you choose to pay interest only for the first 5 years.
You should keep the following in mind:
- Higher borrowing power: Most lenders have restricted interest only loans to 80% of the property value (some up to 90%) but you can potentially borrow up to 95% or even 105% with a guarantor by choosing P&I.
- Reduced interest rates: Making principal and interest repayments makes you a lower risk than a borrower making interest only repayments so banks are willing to offer you cheaper interest rates.
- Potentially pay off the home loan early: P&I repayments might be larger but it means you’re paying off the interest on your home loan or investment loan, saving you thousands over the long term.
- You’re actually paying off the loan: Although the size of your repayments will be smaller, you’re only paying off the interest portion on the loan. You may have a tough time once the interest only period ends and you have to start making large principal and interest payments.
- You won’t be stung by a sudden repayment increase: Interest only loan terms are usually for 5 years, after which your repayments will switch to P&I and you could be caught by surprise.
- It’s a lot easier to refinance: Extending your interest only period with your lender is tough but getting approved for a P&I refinance is a lot easier.
- You’re building equity faster: A strong market will see the value of your property continue to grow and P&I allows you to maximise this equity growth and avoid negative equity by further reducing your principal.
Interest only versus principal and interest calculator
Confused?
Try the IO or P&I calculator to work out the costs of just paying interest only and whether it makes sense for your long term financial goals.
Bear in mind that the calculator only provides dollar figure savings when comparing interest only loans to P&I repayments over a 30-year term.
How you use the savings is the key to making the right decision so speak to your mortgage broker and get financial advice.
Case study of the long-term cost of interest only
Let’s say Jim borrowed $500,000 making standard P&I repayments at an interest rate of 4.78% p.a.
At a Loan to Value Ratio (LVR) of 80% over 25 years, the total cost of interest on the loan would be $357,766.
If Jim were to instead to make IO payments on the same loan amount and LVR, the total cost of interest on the loan would be $440,443 over 25 years.
At the end of the loan term, Jim would pay an extra $82,676 in interest.
Is an interest only loan right for you?
Call us on 1300 889 743 or complete our free assessment form and we can let you know if you qualify for an interest only loan and discuss your long-term plans.