Principal and Interest vs Interest Only: Which Suits You?

The short answer

With principal and interest (P&I), every repayment chips away at your loan. With interest only (IO), you just cover the interest for a set period, so your repayments are lower but your loan doesn’t shrink.

For most people buying a home to live in, P&I is the default. But IO can be a smart tool in the right situation, especially for investors or when you want to keep cash available.

How each works

• Principal and interest: each repayment covers that month’s interest plus a portion of the loan itself. Over time, more goes to the loan and less to interest, and your balance falls until it’s paid off.
• Interest only: for a set period, usually up to five years, you pay just the interest. Your balance stays the same. When the IO period ends, the loan switches to P&I for the remaining term.

Repayment comparison

Example: a $600,000 loan over 30 years at 6.00% p.a.

Loan type	Monthly repayment
P&I for 30 years	about $3,600
IO for the first 5 years	$3,000
P&I for the remaining 25 years, after IO ends	about $3,870

IO saves around $600 a month at the start. But when it ends, you repay the full $600,000 over 25 years instead of 30, so repayments jump by almost $900 a month. Plan for that jump from day one.

The total cost

Because your balance doesn’t fall during the IO period, you pay interest on the full amount for longer.

Using the same example, five years of IO adds about $45,000 in total interest over the life of the loan. And since IO rates are usually higher than P&I rates, the real difference is often greater.

How IO affects borrowing capacity

Lenders don’t assess you on the lower IO repayment. They assess you on the higher P&I repayment over the shorter remaining term, plus the serviceability buffer.

That means choosing IO can reduce how much you can borrow compared with P&I over the full term. If you’re close to your borrowing limit, this is worth factoring in.

When IO can make sense

• Investors: IO on an investment loan can be a tax-effective strategy. See the next section.
• Equity release: if you’re releasing equity for a future purpose, such as an investment deposit or a renovation, setting it on IO preserves your available cash until you use it. You’re not paying down funds you haven’t spent yet.
• Short-term cash flow: lower repayments can help during parental leave, while building, or during a business ramp-up.
• IO with an offset: paying IO while keeping savings in an offset gives you the same interest saving as paying down the loan, with full access to your money if you need it.

Example: Kate releases $200,000 of equity for a future investment deposit. With that split on IO and the funds held in an offset, she isn’t paying down money she hasn’t spent, and the full $200,000 stays available until she finds the right property.

Interest only for investment properties

If you have both a home loan and an investment loan, how you repay them matters as much as the rate.

Pay down your home loan first. Interest on your investment loan is generally tax deductible. Interest on your home loan isn’t. So every extra dollar you put towards your home loan saves interest you’d otherwise pay from after-tax income.

Example: Sam has a $500,000 home loan and a $500,000 investment loan, both at 6.00% p.a., and is in the 39% tax bracket (including the Medicare levy). Every extra dollar Sam puts towards:

Extra repayments go to	Effective interest saved
The home loan (non-deductible)	6.00%
The investment loan (deductible)	about 3.66% after tax

Paying down the home loan first saves Sam more, dollar for dollar. That’s why investors commonly keep the investment loan on IO and direct all spare cash to the home loan, or its offset.

Keep IO on your investment loan for longer, where possible. Holding the investment loan on IO beyond the first period keeps your deductible debt higher, preserves your cash flow, and lets you clear your non-deductible debt sooner. Once the home loan is paid off, you can turn your attention to the investment loan.

Things to keep in mind:

• IO periods have changed: historically, some lenders allowed IO for the full loan term. That changed in 2017, when APRA limited IO loans to 30% of banks’ new home lending. The Banking Royal Commission in 2018 and 2019 then brought tighter responsible lending scrutiny, and most lenders capped IO at five years at a time, with each extension needing a fresh assessment. Today, some lenders can offer investment IO periods of up to 15 years.
• Higher rates: investment IO rates are usually higher than P&I, which eats into the benefit.
• Have an exit plan: your investment loan won’t shrink on IO, so plan how it will eventually be repaid.
• 2026 negative gearing changes: for established investment properties bought after 12 May 2026, how losses can be used for tax may be limited, which can change the numbers.

Tax outcomes depend on your circumstances, so always confirm this strategy with your accountant.

Getting IO approved, and what happens when it ends

• Owner-occupiers: lenders usually want a valid reason for IO, such as parental leave, building or a planned move.
• Investors: IO is more common and generally easier to get.
• When IO ends: the loan reverts to P&I automatically. Extending IO usually means a fresh assessment of your finances, so it’s not guaranteed.

We’ll help you plan for the switch well before it happens, so the higher repayment doesn’t catch you off guard.

Not sure which structure suits you?

With access to over 40 lenders, our team of lending specialists can model P&I and IO side by side, and set up your loan structure to match your goals, now and down the track.

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General information only. This article does not consider your objectives, financial situation or needs and is not credit, financial or tax advice. Lender policies vary and change regularly. Examples are illustrative and rates are hypothetical. Seek advice from a licensed credit adviser and your accountant before acting. Insight Property Finance.