Interest-Only is a loan repayment structure where you only pay the interest charged by the lender for a set period (typically 1-5 years). The loan principal (the amount you borrowed) doesn't reduce—you're servicing the debt, not paying it off.
How Interest-Only Loans Work
For the interest-only period, your repayments cover only the lender's interest charge. The loan balance stays exactly the same.
Example: $500,000 home loan at 6.00% p.a., 5-year interest-only period
- Monthly repayment: $2,500
- Loan balance after 5 years: Still $500,000
- Total paid over 5 years: $150,000 (all interest, $0 principal)
After the interest-only period ends, the loan converts to Principal and Interest (P&I), and your repayments increase significantly.
Interest-Only Repayment Example
Loan: $600,000 at 6.00% p.a.
Years 1-5 (Interest-Only):
- Monthly repayment: $3,000
- Annual repayments: $36,000
- Loan balance: $600,000 (unchanged)
Years 6-30 (P&I over remaining 25 years):
- Monthly repayment: $3,867
- Annual repayments: $46,404
- Repayment increase: +$867/month (+29%)
Why Investors Use Interest-Only
1. Tax Deductibility
For investment properties, interest is 100% tax-deductible. Principal repayments are NOT deductible.
Example: $600,000 investment property, investor on 37% tax rate
- Interest-only repayment: $3,000/month ($36,000/year)
- Tax deduction: $36,000 × 37% = $13,320 refund
- Net cost: $22,680/year ($1,890/month)
With P&I repayments:
- P&I repayment: $3,597/month ($43,164/year)
- Interest portion: $36,000/year (tax-deductible)
- Principal portion: $7,164/year (NOT tax-deductible)
- Tax deduction: $36,000 × 37% = $13,320 refund
- Net cost: $29,844/year ($2,487/month)
Difference: Interest-only saves $597/month in repayments, which investors can use to:
- Cover shortfalls (if rent doesn't cover repayments)
- Invest in other properties or assets
- Build cash reserves
2. Cash Flow Management
Rental income often doesn't cover P&I repayments, but may cover interest-only.
Example: $600,000 investment property
- Rental income: $3,200/month
- Interest-only repayment: $3,000/month
- Cash flow: +$200/month (slight surplus)
With P&I:
- Rental income: $3,200/month
- P&I repayment: $3,597/month
- Cash flow: -$397/month (need to top up from own pocket)
3. Wealth Building via Capital Growth
Investors rely on property value increases (capital growth), not debt reduction.
Example:
- Buy property for $600,000 (5% capital growth per year)
- After 5 years: Property worth $766,000
- Equity gain: $166,000 (plus your deposit)
- Loan balance: Still $600,000
- Net equity: $166,000 from capital growth alone
By keeping repayments low with interest-only, investors can buy multiple properties faster.
Why Owner-Occupiers Rarely Use Interest-Only
❌ Not Building Equity
You're not paying off the loan—just servicing it. After 5 years on interest-only, you still owe the full amount.
Example: $500,000 loan, 5 years interest-only
- Loan balance after 5 years: $500,000
- Total paid: $150,000 (all interest)
- Equity built: $0
With P&I:
- Loan balance after 5 years: $450,000
- Total paid: $180,000
- Principal paid off: $50,000
- Equity built: $50,000
❌ Higher Total Interest
Because the principal doesn't reduce during the interest-only period, you pay more total interest over the life of the loan.
Example: $500,000 loan at 6.00% over 30 years
Scenario 1: P&I for 30 years
- Total interest paid: $579,000
Scenario 2: Interest-Only for 5 years, then P&I for 25 years
- Interest paid years 1-5: $150,000
- Interest paid years 6-30 (P&I over 25 years): $483,000
- Total interest paid: $633,000
- Extra cost: $54,000
❌ Repayment Shock When Converting to P&I
When the interest-only period ends, your repayments jump significantly.
Example: $600,000 loan at 6.00%
- Interest-only: $3,000/month
- P&I (over remaining 25 years): $3,867/month
- Increase: +$867/month (+29%)
Many borrowers struggle with this sudden increase and face financial stress.
When Interest-Only Makes Sense for Owner-Occupiers
✅ Short-Term Ownership
If you're buying, renovating, and selling within 2-3 years, interest-only minimizes repayments during the flip.
Example: Fix-and-flip strategy
- Buy rundown property for $500,000
- Interest-only repayments: $2,500/month (affordable while renovating)
- Renovate over 12 months
- Sell for $650,000
- Profit: $150,000 (minus costs)
✅ Temporary Cash Flow Crunch
If your income is temporarily reduced (parental leave, starting a business), interest-only can provide short-term relief.
Example:
- Normal income: $10,000/month (can afford $3,597 P&I)
- Parental leave: $4,000/month (struggle with $3,597 P&I)
- Switch to interest-only: $3,000/month (manageable)
- Return to work after 12 months, switch back to P&I
Caution: Only use interest-only if you have a clear plan to return to P&I or increase income.
The Hidden Risks of Interest-Only
1. Negative Equity if Property Values Fall
If property values drop and you haven't paid off any principal, you could owe more than the property is worth.
Example:
- Buy property for $700,000 with $70,000 deposit (90% LVR)
- Loan: $630,000 (interest-only)
- After 3 years: Property market crashes 15%
- Property now worth: $595,000
- Loan balance: Still $630,000
- Negative equity: -$35,000
You can't sell without bringing $35,000 cash to the settlement, and refinancing becomes impossible.
2. Lenders Tightening Criteria
Since 2018, banks have restricted interest-only lending. You may not be able to extend or refinance interest-only.
Current rules (2026):
- Maximum 5 years interest-only for investors
- Maximum 80% LVR for interest-only
- Lenders assess your ability to afford P&I repayments (even if you're on interest-only)
3. Longer Path to Debt Freedom
If you're on interest-only for 5 years, you're delaying debt reduction by 5 years.
Example:
- P&I from day one: Loan paid off in 30 years (age 60)
- Interest-only for 5 years, then P&I: Loan paid off in 35 years (age 65)
Switching from Interest-Only to P&I
Most borrowers on interest-only either:
- Refinance to a new 30-year P&I term (lowers repayments vs 25 years remaining)
- Sell the property and use proceeds to pay off the loan
- Extend interest-only for another 1-5 years (if lender allows)
Refinancing example:
- After 5 years interest-only, $600,000 loan balance remains
- Option 1: Convert to P&I over 25 years = $3,867/month
- Option 2: Refinance to new 30-year P&I term = $3,597/month
- Savings: $270/month (but you're extending the loan by 5 years)
Interest-Only for Construction Loans
Interest-only is standard during the construction phase of a new home because you're not living in it yet.
Example: Building a $700,000 home
- Construction period: 12 months
- Progressive drawdowns as building progresses
- Interest-only repayments: Start at $1,000/month, increase to $3,500/month as funds are drawn
- Once construction completes: Convert to P&I over 30 years
Current Interest-Only Rates (Feb 2026)
Interest-only rates are typically 0.10-0.30% higher than P&I rates:
- P&I rate: 5.89% p.a.
- Interest-only rate: 6.19% p.a.
Example: $600,000 loan
- P&I at 5.89%: $3,540/month
- Interest-only at 6.19%: $3,095/month
- Repayment saving: $445/month
- But: You're paying 0.30% more in interest and not reducing the principal
Final Thoughts
Interest-only loans are a powerful tool for property investors who want to maximize tax deductions and cash flow. They're rarely suitable for owner-occupiers unless you have a specific short-term strategy.
Key takeaways:
- Interest-only = lower repayments now, higher total interest later
- Best for investors using negative gearing and capital growth strategies
- Risky for owner-occupiers (no equity built, repayment shock later)
- Always have a plan for what happens when the interest-only period ends
Speak to a NIK Finance broker and a tax advisor to determine if interest-only fits your investment strategy. If you're an owner-occupier, P&I is almost always the better long-term choice.