An interest only home loan lets you pay just the interest on your mortgage for an agreed period, so nothing comes off the amount you borrowed. Your repayments are lower while that period runs, and then they jump — often sharply — because the full balance still has to be repaid over a shorter remaining term. That trade-off is the whole story, and it is why this structure suits some borrowers and quietly hurts others.
The detail matters more than the headline repayment. Australia's regulators treat this product as higher risk for a reason, lenders assess it differently, and the total interest you pay over the life of the loan is larger, not smaller. If you are weighing it up, the sections below set out how it works, what the end of the term really looks like, and when it is worth getting a broker to run the numbers with you.
What is an interest only home loan?
It is a mortgage where, for a set number of years, your repayment covers interest and nothing else. The principal — the amount you actually borrowed — stays exactly where it started.
- Repayments during the term cover interest charges only, so the balance does not reduce.
- The interest only period is agreed upfront with the lender and is temporary, never the full loan term.
- When it ends, the loan reverts to principal and interest for the remaining years.
- Because no principal has been paid, that remaining term is shorter than the original one.
- The interest rate on these loans can be higher than the equivalent principal and interest rate.
ASIC's MoneySmart guidance on interest-only home loans puts it plainly: you pay more over the life of the loan, and if rates rise your repayments go up even further.
How does an interest only mortgage differ from principal and interest?
The mechanical difference is simple; the financial difference is not. With a principal and interest loan every repayment chips away at the debt, so you build equity from month one. With an interest only mortgage you buy cash flow now and pay for it later.
- Equity: principal and interest builds it steadily, interest only relies entirely on the property's value rising.
- Repayment shape: one is flat and predictable, the other is low then considerably higher.
- Total cost: paying interest on an unreduced balance for years costs more overall.
- Flexibility: lower repayments free up cash for other commitments while the term runs.
- Risk: if the property's value does not grow, you can reach the end of the term with no equity gained.
Interest only vs principal and interest: what does the extra cost look like?
MoneySmart's own worked example is the clearest illustration available from a regulator. It compares a $500,000 loan over 25 years at a 4.8% comparison rate, with a five year interest only period against a standard principal and interest loan.
| Loan structure | Repayment during first 5 years | Repayment after year 5 | What happens to the balance |
|---|---|---|---|
| Interest only (5 years) | $2,010 a month | $3,250 a month | Unchanged for 5 years |
| Principal and interest | $2,875 a month | $2,875 a month | Reduces from the first repayment |
Two things stand out. The early saving is real but modest, and the later repayment is well above what the principal and interest borrower ever pays. The borrower in that example chose principal and interest precisely because the higher later figure was out of reach. Our repayment calculators let you test the same comparison against your own balance before you speak to anyone.
What happens when the interest only period ends?
This is the part borrowers underestimate. The loan converts to principal and interest automatically, and the full original balance now has to be cleared over fewer remaining years.
- Repayments rise because principal is added and the repayment term has shortened.
- Any interest rate increase since you started compounds that jump.
- Extending the interest only term is possible with some lenders but requires a fresh assessment.
- Switching to principal and interest early is usually allowed and reduces total interest.
- Refinancing is an option, but it depends on your income, equity and credit position at that time.
If the new repayment does not fit your budget, the time to work that out is years before the term expires, not the month it does. A conversation about refinancing started early gives you far more options than one started under pressure.
Who does an interest only home loan actually suit?
MoneySmart lists the genuine use cases, and they are narrower than the marketing suggests. An interest only home loan is a cash flow tool, not a cheaper mortgage.
- Property investors who want deductible interest and predictable holding costs while a property is tenanted.
- Short-term lending such as bridging finance or a construction loan, where the structure matches the timeline.
- Borrowers with a clear, dated plan for the money the lower repayments free up.
- Owner-occupiers facing a temporary, genuinely short-term squeeze in income.
It is a poor fit for anyone relying on property values rising to cover the shortfall, or anyone who would struggle with the reverted repayment. Investors in particular should think about structure before settlement, which is where an investment property mortgage broker earns their keep.
How do lenders assess an interest only loan application?
Lenders do not assess an interest only loan on the low repayment you will actually make. APRA's prudential expectations push them to test something harder.
- Serviceability is tested on principal and interest repayments over the actual repayment period, excluding the interest only term.
- APRA expects interest only periods to be "of limited duration, particularly for owner-occupiers".
- Lenders are expected to hold prudent internal limits on the volume and type of interest only lending they write.
- Owner-occupier interest only lending and high loan-to-value lending draw the closest scrutiny.
- The regulator's 30% interest only benchmark for new lending was removed from 1 January 2019, but the risk treatment remains.
APRA set this out in its letter on interest-only benchmarks of 19 December 2018. The practical effect is that your borrowing capacity on this structure is often no larger than it would be on a standard loan, and sometimes smaller.
What should you check before you commit?
In our experience, across the conversations our team has with borrowers each month, the same handful of questions separate a structure that works from one that causes trouble three years in. Policy on this product varies widely between the 30+ lenders on our panel, which is exactly why comparing matters here more than on a vanilla loan.
- The exact reverted repayment in dollars, calculated at a rate above today's, not the current one.
- Whether the lender's interest only rate carries a premium over its principal and interest rate.
- The maximum interest only period that lender allows, and whether extensions are assessed as a new application.
- What happens to the remaining term, since a shorter term is what drives most of the repayment jump.
- Whether an offset account or extra repayment facility is available alongside the loan.
- Your own plan for the freed-up cash flow, written down, with a date attached.
Walking through those with home loan brokers in Melbourne who can see how different lenders treat the same application is usually faster than calling three banks yourself. If the answers make you uncomfortable, that discomfort is useful information.
This article is general information only and does not take your personal circumstances into account. Before you choose an interest only structure, consult a licensed mortgage broker or financial adviser about your own position. Spotto Finance holds an Australian Credit Licence (CRN 564353).
Frequently asked questions
What is an interest only home loan?
It is a mortgage where your repayments cover only the interest charged for an agreed period, so the amount you borrowed does not reduce at all during that time. When the interest only period ends the loan reverts to principal and interest and the full original balance must be repaid over the remaining years.
Is an interest only home loan cheaper?
No. The repayments are lower while the interest only period runs, but you pay more over the life of the loan because interest keeps accruing on a balance that is not reducing. ASIC's MoneySmart guidance states plainly that you pay more over the life of the loan, and the interest rate itself can be higher than on an equivalent principal and interest loan.
How much do repayments rise when the interest only period ends?
That depends on your balance, the remaining term and the rate at the time. In MoneySmart's published example a $500,000 loan over 25 years at a 4.8% comparison rate moves from $2,010 a month during a five year interest only period to $3,250 a month afterwards, while the equivalent principal and interest repayment stays at $2,875 throughout. Ask your broker or lender to calculate your own figure at a rate above today's.
Who do interest only home loans suit?
MoneySmart points to property investors seeking deductible interest, short-term lending such as bridging finance or construction loans, and borrowers who can genuinely put the freed-up cash flow to better use. They suit owner-occupiers far less often, and they are a poor fit for anyone who would struggle with the higher reverted repayment.
Can you extend an interest only period?
Some lenders allow it, but an extension is assessed like a new application against your income, expenses and credit position at that time. APRA expects interest only periods to be of limited duration, particularly for owner-occupiers, so an extension is never guaranteed. Starting the conversation well before the term expires gives you more options.
How do lenders assess an interest only application?
Not on the low repayment you will actually make. Following APRA's prudential expectations, lenders test your ability to repay principal and interest over the actual repayment period, excluding the interest only term. That means your borrowing capacity on this structure is often no larger than on a standard loan, and sometimes smaller.
Can you switch from interest only to principal and interest early?
Usually yes, and doing so reduces the total interest you pay because the balance starts reducing sooner. Policy and any associated fees vary between lenders, so check the terms of your specific loan. A broker can compare how different lenders handle the switch before you commit to a structure.