Every home loan repayment either pays down the loan balance (principal) or covers the cost of borrowing (interest). The choice between principal-and-interest (P&I) and interest-only (IO) repayments is one of the most consequential decisions in your loan structure.
With a P&I loan, each repayment covers the interest accrued in the period plus a portion of the principal. In the early years, the majority of each repayment is interest — on a 30-year $600,000 loan at 6.5%, the first repayment of approximately $3,792 comprises roughly $3,250 interest and only $542 principal. As the principal reduces over time, the interest portion shrinks and the principal portion grows. By year 25, the same repayment is mostly principal.
P&I loans are the standard for owner-occupiers. They build equity progressively, reduce total interest paid, and the loan is fully repaid at the end of the term.
With an interest-only loan, repayments cover only the interest — the principal balance does not reduce. On a $600,000 loan at 6.8% (a typical investor rate) on a 5-year IO term, the monthly repayment is approximately $3,400 — compared to $3,900+ for P&I. The loan balance at the end of 5 years remains $600,000.
After the IO period ends, the loan converts to P&I on the remaining balance over the remaining term. The repayment jump can be significant. A $600,000 loan starting 5-year IO at 6.8% then converting to P&I over the remaining 25 years sees repayments increase from $3,400 to approximately $4,200/month — a $800/month step-up.
IO loans are most commonly used by:
IO for owner-occupiers without a specific financial strategy is generally poor practice — you build no equity, pay more total interest, and face a repayment shock when the IO period ends.
On a $600,000 loan at 6.5% over 30 years:
The extra cost of interest-only reflects the fact that you have done nothing to reduce the principal in the first 5 years, so you pay full interest on the original $600,000 for that period rather than a progressively declining balance.
Most lenders cap IO periods at 5 years (with some extending to 10 years for investment loans). APRA periodically restricts interest-only lending at the sector level when it judges aggregate risk to be elevated. During restriction periods, some lenders may not offer IO at all or may charge a larger rate premium.
Re-fixing or extending IO: At the end of an IO period, you can apply to extend it — but this is subject to re-assessment at current rates and policy. If your financial circumstances have changed or APRA restrictions are in place, extension may not be approved at your preferred rate.
For most owner-occupiers: P&I. You build equity, reduce interest costs, and have a clear path to owning your property outright. For investors with a clear tax strategy: IO may make sense during the period you are maximising tax deductions and directing surplus cash flow to paying down the owner-occupied home. Always model the total cost before deciding, and consider the repayment shock at IO period end.
How investment loans differ and when IO makes sense for investors.
Read guide →How an offset account can reduce interest without paying down principal early.
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