Interest-only home loans

An interest-only loan can be a useful way of getting a foothold on the property ladder, as long as you have carefully weighed the benefits against the potential drawbacks before you commit to the loan. Learn about interest-only loans and compare lenders’ offers here.

By   |   Verified by David Boyd   |   Updated 13 Mar 2024

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Comparing interest-only home loans for over years

Virgin Money Standard Variable Rate (Investor, Interest Only)

Virgin Money Standard Variable Rate (Investor, Interest Only)

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  • Split your borrowings and lock in a portion of your loan with a fixed rate to get repayment certainty over a fixed period.
  • Rate discounts based on LVR and loans size for loans with an LVR of 90% or under.
ANZ Simplicity PLUS

ANZ Simplicity PLUS

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  • Get $2,000 cashback when borrowing 80% or less of the property value or get a $3,000 bonus for first-home buyers.
  • Competitive variable interest rates and no monthly fee.
  • Make extra repayments at any time.

An interest-only loan can be a useful way of getting a foothold on the property ladder, as long as you have carefully weighed the benefits of this particular type of home loan against the potential drawbacks before you apply. If you have an interest-only loan, your periodic repayments will consist entirely of interest charges, and the principal amount will not reduce. At the end of the loan term the full principal amount has to be repaid, unless the terms of the loan dictate that payments will revert to normal 'principal plus interest' payments after a specific number of years.

Reasons for using an interest-only home loan

There are four main situations in which interest-only home loans may be useful, and may be offered by lenders:

  1. Construction loan. Interest-only home loans are typically offered to borrowers who are having a new home built. This type of borrowing works well during the construction period, when progress payments are being made to the builder and the full loan amount has not been drawn down. Once the home is completed, and the total principal amount has stabilised, the loan will usually revert to a standard fixed or variable interest loan, where each periodic repayment includes a portion of the principal as well as interest.
  2. Bridging loan. If you already have a loan secured against your existing home, but want to buy a new property, ideally you need to sell your existing home first so that you can use the equity as a deposit against a new property. But it can be difficult to get the timing just right, and many borrowers find themselves in a situation where they need a bridging loan for a limited period of time, so that they can temporarily finance both properties and then lock in a standard loan on their new home once their first home is sold. Bridging loans will typically be interest-only loans.
  3. Lower loan repayments. An interest-only home loan can also work where the borrower has a limited budget and can only afford to make interest payments, without repaying any of the principal. In the past this was a popular option, but both the Australian Prudential Regulation Authority (APRA) and banks themselves have tightened lending conditions for interest-only loans, to avoid letting borrowers commit to loans they cannot really afford.
  4. Investment property. Borrowers who are buying an investment property may choose an interest-only home loan in order to maximise their tax deduction. Home loan principal payments are not tax deductible for investors, but they can claim 100% of their repayments as a tax deduction if they only consist of interest charges. Interest-only loans are also useful in a negative gearing situation, keeping payments low while the investor waits for the asset to hopefully increase in value as a result of a general lift in property values.

Learn about interest-only home loans

Learn about when an interest-only home loan makes sense and the problems to be aware of.

  • FAQs

  • Pros & cons

  • Tips

What is an interest-only home loan?

The majority of home loans are ‘principal plus interest’ loans. Borrowers are required to repay a portion of the loan principal, along with periodic interest charges, every time they make a regular scheduled repayment. As a result, the principal gradually declines. At the beginning of the borrowing term only a very small amount of the principal is being repaid, but as the years pass, principal payments account for a larger and larger portion of the periodic repayment. The last few payments are almost entirely payments of the remaining principal amount.

But interest-only loans are different. As the name implies, the borrower is only required to repay interest charges when making regular payments. As a result, the required weekly, fortnightly or monthly repayments will be lower than it would have been if a portion of the principal was also being repaid. The principal does not reduce but remains the same throughout the interest-only period of the loan.

Are interest-only home loans a good idea?

Interest-only loans can be a good idea for certain types of borrowers, such as investors, home buyers who need a bridging loan and 'new build' construction loans, provided they are aware of some of the potential pitfalls. (See more details of pros and cons below.) They are not really a good idea for people who simply cannot afford standard monthly payments of interest plus a part of the principal.

Can you still get interest-only home loans?

Yes, although it's a bit more difficult than it used to be, for owner-occupiers in particular. The Australian Regulation Prudential Authority (APRA) set a limit in March 2017, so that lenders could only issue interest-only loans as 30% of their new home loans. This restriction was gradually lifted from January 2019 onwards, but the easing operates in tandem with a requirement for stricter application processes to make sure that borrowers can actually afford to make principal-plus-interest payments – in which case they would not need an interest-only loan.

What is a typical term for an interest-only home loan?

The term may be anywhere between one and five years, although investors may be able to negotiate a longer term. At the end of the interest-only term, the loan will revert to being a regular loan where repayments include interest plus principal. As a result, the required repayment will suddenly increase.

Can I refinance to an interest-only home loan?

There are two ways of refinancing to an interest-only loan – switching to this kind of loan with your current lender, or changing to a new interest-only lender who will pay out your current loan. Either way, there will probably be some additional costs involved, especially with a new lender.

If you're refinancing because you're struggling to meet your current repayments and want to make them smaller in the short term, you need to be aware that this type of financing will see you paying more over the long term.

It makes more sense to switch to interest-only as an investor, if your current investment property has standard 'principal plus interest' finance, or if you're planning to turn your current owner-occupier property into an investment property by renting it out.

Is taking out an interest-only loan better than renting?

It depends on a number of factors:

  • Do you rent, or are you planning to rent, in an area where landlords are getting a significant return on their property investment in the form of high rents? In this case your interest-only monthly repayment could be less than your monthly rental payment.
  • Do you want the security of owning your own place, rather than the relative insecurity of being a tenant?
  • Do you expect that property values will increase in your chosen area? In this case an interest-only loan will put the profit in your pocket rather than your landlord's.

But in all of these scenarios there's always a risk. You will need to be sure that the property value will not fall, because you are not building up any equity in your home via principal repayments.

Can I make lump sum extra payments on an interest-only loan?

Yes, it is sometimes possible. It depends on the lender and the conditions of your loan, but it would be a good idea to look for a loan that does allow you to make extra payments. That's because if you reduce the principal amount, the monthly interest charges will go down as well, and you will also be building up equity in your property.

Or you could look for a loan with an offset account facility. This means that if you leave your spare cash in the offset account, this amount will be deducted from your principal when your monthly interest charges are being calculated.

Lower repayments

For borrowers on a tight budget, kicking off the loan with an interest-only period means that repayments will be lower at the start. This can also be useful if you need to carry out expensive renovations in the early years.

Good for investors

If you are buying an investment property, an interest-only loan will deliver a tax deduction of 100% of your repayments in most cases.

Good for construction loans

Paying interest alone is ideal when the amount borrowed is gradually increasing while builders and material suppliers are being paid via a construction loan. Once the build is complete and the final principal amount is fixed, you can revert to a standard 'principal and interest' loan.

Good for bridging loans

When you're buying a second property before you've completed the sale of the first, you're probably going to need a bridging loan. Bridging loans are usually interest-only in order to minimise costs while you are under a measure of financial stress.

Only short-term

Unless you're a property investor, you probably won't be able to negotiate an initial interest-only period of longer than five years.

Repayments will increase

If you can only just afford the payments during the interest-only period, you may be unable to afford the payments when the interest-only period comes to an end and you need to start including a portion of the principal, as well as interest, in your repayments. Your repayments may increase significantly.

You won't build up equity via repayments

Your principal will not reduce, so if property market values are falling, or you need to sell your home because your circumstances have changed, there is a risk that the amount you owe will end up being greater than the value of the property on which it is secured. This is known as ‘negative equity’.

Possibly higher interest rates

The interest rate offered for an interest-only loan will usually be higher than the rate offered for a ‘principal and interest’ loan.

More expensive in the long run

Interest-only loans usually work out to be more expensive in total over the life of the loan. This is because there has been no reduction on the principal in the early years, so you will pay more interest in the long run.

Consider all features of the package

Just because you're getting an interest-only loan, it doesn't mean that you shouldn't compare the loan's other features with those of competing interest-only offers. You should check for:

  • How much the interest rate is, including the comparison rate
  • Whether the interest rate is fixed or variable, and the pros and cons of each type of rate
  • What all the associated fees are, since not all fees are included in the comparison rate
  • Whether extra payments to reduce the principal are allowed
  • Whether there's an offset account facility

Work out repayment affordability once the interest-only period ends

Before you take out an interest-only loan, find out what the amount of your periodic repayment will be once the interest-only period ends, to make sure that you will still be able to afford it.

Make good use of your offset account

During the interest-only period, try to maximise the cash you leave in your mortgage offset account (if you have one) so that your interest payments will be lower. You can use this cash as a buffer once your payments increase at the end of the interest-only period.

If you don't have an offset account, an alternative would be to put some money away in a savings account where it can accrue interest.

Pay off lump sums if you can

If you don't have an offset account your lender may still allow you to make voluntary extra payments to reduce the principal. This would let you build up equity in your home as well as reducing your interest payments.

Gradually work up to principal and interest repayments

When the interest-only period nears its end, try to gradually increase the payments you are making (if your lender allows this) until they are equal to the required repayment once the ‘principal and interest’ period kicks in. This will help you to get used to the idea that you will have less spare cash.

Check your budget for potential savings

Take a look at your budget to see if there are any savings you can make so that you can more easily manage the increased repayments once your interest-only period ends.

Options if you won't be able to afford increased repayments

If the end of the interest-only period is approaching and your financial situation means that you will not be able to meet the increased repayment amount once principal payments are included, you have the options of:

  • Asking for a further interest-only period with your existing lender
  • Trying to negotiate a better rate for the ‘principal and interest’ loan with your existing lender
  • Asking your existing lender to lengthen the loan term in order to reduce your periodic payments
  • Refinancing your loan with a new lender – you may incur extra fees for refinancing