Interest-Only Home Loans

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Written by

Luke Carlino

Updated 18/03/2023

What changed?

Moderate rewrite for tone and to expand content
Our aim is to help you make better informed decisions. That’s why iSelect’s content is produced in accordance with our fact-checking and editorial guidelines.

Find out more about how we make money.

View our Privacy Policy.

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What is an Interest-Only Home Loan? 

With an Interest-Only Home Loan, you’re just paying back the interest part of your loan, not the whole shebang (the principal). You’ll do this for a set period, such as five years. Over that period, your monthly repayments will be less, which can feel like a win.  

But here’s the catch: since you’re not chipping away at the actual loan amount during this interest-only phase, you’ll probably end up paying more interest over the whole course of your loan. Interest is calculated on your outstanding loan balance, so the longer that amount is higher, the more interest you’ll pay. 

How are Interest-Only Home Loans structured? 

Let’s say you’re buying your dream home for $650,000 and can put $50,000 down towards it. You’ve decided to go for an Interest-Only Home Loan for the remaining $600,000 to keep your initial monthly repayments low. Let’s say you have a 30-year loan, with fixed rates of 6.2% for the first 10 years and interest-only repayments for the first five: 

Year Interest-only payments Principal and interest payments 
$37,200 – 
$37,200 – 
$37,200 – 
$37,200 – 
$37,200 – 
– $61,200 
– $59,712 
– $58,224 
– $56,736 
10 – $55,248 

Year 1–5 (interest-only period) 

This cost covers only the interest on the loan, leaving you with extra cash for other expenses and investments. You have flexibility and financial freedom in these initial years. 

Year 6–30 (principal and interest period) 

After the interest-only phase, you’ll start paying back the principal and interest, increasing the monthly payments. Although the monthly payments go up, you are gradually reducing the loan balance, building equity in the home, and working towards full ownership. 

And as you can see, once you start paying off the principal, the annual repayment amount starts to decrease. That’s because you pay interest on the total principal loan amount you have outstanding. Principal goes down, interest goes down, repayments go down! 

Is an Interest-Only Home Loan right for me? 

Interest-Only Home Loans have been a hit with folks in a couple of situations. First, property investors love them. They snag a property, hold onto it for five years, wait for the market to do its thing, and then sell it to pay off the loan and pocket the profits.  

Then there’s the situation where you’re building a house or giving your place a significant face lift. You need somewhere to crash while the magic happens, and Interest-Only Home Loans come in handy here, too. They can help you juggle rent and mortgage payments without breaking the bank. 

Important note: Interest-Only Home Loans are like tools in a toolbox. They’re best used for specific jobs, like the scenarios above. They’re not a forever solution, so it’s always a good idea to use them strategically. 

What are some benefits of an Interest-Only Home Loan? 

Interest-Only Home Loans can do more than just drop your monthly bills. They’ve got some perks, especially in the short run, like potential tax goodies. Here are some of the short-term benefits these loans might bring your way: 

Lower monthly payments 

During the interest-only period, your monthly payment will be lower. Just keep in mind that this low-payment party doesn’t last forever. Interest-Only Home Loans are great for short-term savings, but over the life of the loan, you’ll be paying more.  

Tax deductions 

If you’re an investor, Interest-Only Home Loans could be your ticket to some sweet tax benefits. Interest payments are fully tax deductible for investors, so if you’re only paying interest, you can deduct the whole amount.  

There’s also a little something called negative gearing. It’s what happens when your interest and property costs are more than what you make from your investment, and it means getting a tax break on those losses. We recommend chatting with a tax whiz to help you navigate this.  

Extra cash 

Going interest-only means that, for the interest-only period, you’ve got some extra cash in your pocket. What can you do with it? Treat yourself to some non-deductible splurges or expand your real estate empire? 

What are some drawbacks of an Interest-Only Home Loan? 

You know that old saying ‘there’s no such thing as a free lunch’? Sadly, that’s true here. Before diving in, it’s advisable to carefully weigh up the advantages against the disadvantages. What disadvantages, you ask? Here are a few: 

The clock is ticking 

Remember, the interest-only honeymoon doesn’t last forever. Unless you’re planning to flip a property quick smart, the day will come when you start chipping away at that principal, which will increase your monthly repayments.  

Property prices can be erratic 

If you get an Interest-Only Home Loan as an investor, you might be relying on the property to have increased in value by the time you sell it, leaving you with a profit. But it’s always possible your property value won’t increase, or even that it’ll fall.  

A false sense of security

Extra cash is sweet, but with more money in your pocket, your lifestyle changes and overspending might become your new hobby. When the time comes to pay off the principal, you could be in for a rough ride. Stay sharp, and budget wisely! 

What else should I keep in mind? 

If you’re jumping on the Interest-Only Home Loan wagon, the golden nugget of wisdom is to keep a close eye on what you’ll be shelling out when that interest-only joyride ends. If you can’t handle the higher payments, you could end up in a sticky situation. And if interest rates increase further, your payments could skyrocket even more.  

If you’re switching from a Principal and Interest Loan to an Interest-Only Loan, and if your lender allows it, consider throwing in some extra cash here and there before the switch. It’s like a financial warm-up, preparing you for the big game. 

Last but not least, if you’re getting that sinking feeling that you’ll be drowning in payments once your interest-only period ends, don’t sweat it alone. Talk to your lender ASAP or get a financial guru to help you figure out a game plan. It’s better to tackle it head-on than let it sneak up and surprise you! 

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iSelect is the trading name of iSelect Mortgages Pty Ltd (ABN 86 148 217 181). iSelect Mortgages Pty Ltd is a credit representative (Credit Representative 400540) of Lendi Group Distribution Pty Ltd (Australian Credit Licence 246786). iSelect provides a referral to Lendi Pty Ltd, a Credit Representative of Lendi Group Distribution Pty Ltd (Australian Credit License 246786). iSelect Mortgages Pty Ltd receives a commission from Lendi Group Distribution Pty Ltd, the licensee for each new customer account created and for each home loan submitted through this service.