More expensive in the long run
An interest-only home loan is a type of loan where your
repayments only cover the interest on the amount you have borrowed,
during the interest-only period. There is no reduction in the
This type of home loan will have lower repayments in
the short term and may provide greater tax deductions on an
investment property, but will be more expensive in the long
run. Here we explain the risks and benefits of interest-only
How do interest-only loans
Most home loans are 'principal and interest' loans, which
means your repayments reduce the principal (amount
borrowed) and cover the interest for the period.
With an interest-only loan, you only pay the interest on
the amount you have borrowed.
These loans are usually for a set period (for example,
5 years) after which the loan changes to a principal and
interest loan. Interest rates on interest-only loans are often
higher than for standard principal and interest loans.
Before you take out an interest-only home loan, work out how
much the repayment will be at the end of the interest-only
period to make sure you can afford the increased amount.
Work out your repayments before and after the interest-only
Australia's interest-only mortgages
Our interest-only mortgages
infographic explains how many Australians have
an interest-only mortgage and how much you will really
pay for this type of home loan.
Reduce your interest payment with an offset account
An offset account can reduce the amount
of interest you pay on your home loan. You can use an
offset account for savings or as an everyday transaction
An offset account allows you to combine your savings with your
mortgage account, reducing the amount of money owing on your
mortgage, which reduces the amount of interest calculated on your
home loan. Offset accounts are much more effective if you put money
in and leave it there.
Case study: Violet and James get an interest-only loan
Violet and James took out a $500,000 home loan over 30
years, with an interest-only period of 5 years. They planned to
reduce the interest on the loan by putting their
savings into an offset account.
Two years into the mortgage, they decided to travel
overseas for a few months and used the money in
their offset account to fund the trip. When they
returned home, they realised they'd run up quite a
big credit card debt. Paying off the credit card meant they no
longer had money to put into their offset account. With no
money in their offset account, their interest repayments
When the interest-only period ended, they still
owed $500,000 but only had 25 years left to pay it back. Their
repayments were suddenly a lot higher and they struggled to keep up
with all their bills.
Risks of interest-only home
Interest-only home loans seem more affordable because
initially the repayments are lower than the repayments
on principal and interest loans, but they have some
- Interest-only loans cost more - The amount of
money you owe does not reduce during the interest-only period,
which means you'll pay a lot more interest over the life of the
loan, compared to a principal and interest loan. For example, a
$500,000 loan over 25 years, with an interest rate of 5%, would
cost you an extra $40,062 in interest if it was interest-only for
the first 5 years.
- Repayments will increase at the end of
the interest-only period - When the interest-only
period ends you'll need to start repaying the principal as well as
the interest - and, with less time to pay it off, your repayments
are likely to be a lot higher.
- Not building equity - If your property does
not increase in value during the interest-only period, you risk
having no equity in your home at the end of this period, despite
making payments every month. This may put you at greater risk if
there is a downturn in the market or your circumstances change and
you have to sell.
Case study: Daisy's interest-only loan repayments
Daisy found her dream apartment
and was looking at different loans online. She wanted to
borrow $500,000 and repay it over 25 years. Comparison rates
at the time were around 5% per annum.
Daisy compared a loan with an interest-only period of 5
years to a standard principal and interest loan. The
interest-only loan would make her repayments much lower in the
short-term but she was worried she might not be able to make
the increased loan repayments when the interest-only
Daisy used ASIC's MoneySmart's interest-only mortgage
calculator to compare the two loans.
Inital repayments on the interest-only loan were $2,083 per
month, increasing to $3,300 a month at the end of the
Daisy didn't think she could afford the increased monthly
repayments when the interest-only period ended and decided
that a principal and interest mortgage, with constant repayments of
$2,923 per month would suit her better in the long term.
Benefits of interest-only
Interest-only home loans can provide some short-term benefits,
- Lower repayments at the start of the loan -
This may help you maximise the amount of money you can borrow or
give you the opportunity to pay off other high-interest debt.
- Maximum tax deductions - Investors sometimes
choose an interest-only loan to increase their tax deductions,
which reduces their tax payable. Find out more about property
- Management of short-term lending needs -
These loans are useful for transitional borrowing needs, such as
bridging or construction loans.
How to manage when an
interest-only loan changes to a principal and interest loan
Interest-only loans usually have a set interest-only period,
after which the loan becomes a standard principal and interest
loan. When the loan switches over, you will have to start repaying
the principal as well as the interest, which can greatly increase
your loan repayments. Here are some tips to help make the
Gradual loan repayment increase
If your loan allows you to make extra repayments, you may find
it easier to increase your repayments gradually in the lead up to
the switch to principal and interest.
For example, if your loan repayments will increase by $1,300 a
month, you could increase your repayment by $100 a month in the 13
months before the switch.
Loan repayment increase fast approaching
If your mortgage repayment is about to increase significantly
and you're worried you can't afford the new repayments, here are
some things you can do:
- Re-do your budget - Reviewing your budget may help you
find savings elsewhere that could soften the blow.
- Ask for a reduction in your interest rate -
Use a comparison website to see
what loans are available from different credit providers and ask
your lender to match a lower rate for a similar product.
- Refinance your loan - If your lender won't
offer you a better deal you might consider switching
home loans. Be aware that switching home loans could extend the
life of your loan and/or you may have to pay lender's mortgage
insurance (LMI) again, which could cost you more in the
What if you can't afford your increased loan repayments?
If your interest-only loan has already changed to principal and
interest and you can't afford the repayments, contact your lender
immediately to negotiate a repayment plan. Here are some options
you can ask for:
- Extend your loan period, so you make smaller repayments over a
- Postpone your repayments for an agreed period
- Extend your loan period AND postpone your repayments for an
When negotiating a repayment plan, make sure you can afford it.
There is no point agreeing to an amount that is unaffordable.
Taking action straight away can stop a small problem becoming a
big one. Most banks have hardship officers who can assess your
situation and work out what help is available.
If you're considering an interest-only loan,
think carefully about whether it's the right loan for you.
Last updated: 19 Oct 2018