What is an interest-only home loan?

Interest-only home loans are popular for borrowers looking to minimise monthly repayments in the early years of a loan.

But how do they work, and are they the right choice for you?

In this blog post, our Brisbane mortgage brokers explain how interest-only home loans function. We uncover who they’re best suited for as well as key benefits and risks to consider.

Paying interest only on a home loan: how exactly does it work? 

An interest-only home loan allows borrowers to pay only the interest portion of their loan for a set period. This can be combined with an offset account to reduce overall interest costs.

During this time, the principal (the original loan amount) remains unchanged. This means that repayments are lower than a standard principal and interest (P&I) loan.

Once the interest-only period ends, the loan reverts to principal and interest repayments. This means your monthly repayments will increase as you start repaying the principal in addition to the interest.

Key features of an interest-only loan

Lower initial repayments

Because you’re only paying interest, your short-term cash flow improves.

Fixed term

The interest-only term is usually 5, 7, or 10 years, after which you start repaying the principal.

Higher long-term costs

Since the principal isn’t reducing during the interest-only phase, you’ll pay more in interest over the life of the loan.

Available for various loan types

Can be applied to owner-occupier or investment loans, though stricter lending rules may apply to owner-occupiers.

Who is an interest-only home loan best suited for?

Property investors

Investors often use interest-only loans to maximise tax benefits and improve cash flow while expecting property value appreciation.

Borrowers needing short-term affordability

If you need lower repayments for a few years (like during a career change or while managing other financial commitments), this loan can provide flexibility.

Those expecting a future income increase

Borrowers who anticipate higher earnings in the future may opt for an interest-only loan. It can ease short-term financial pressure before transitioning to principal and interest repayments.

Homeowners planning to sell or refinance

Planning to own the property for a few years before selling or refinancing? An interest-only loan can minimise costs in the short term.

Self-employed borrowers with variable income

Business owners or freelancers with fluctuating income may use interest-only loans. This helps them manage cash flow during slower periods while maintaining flexibility for higher repayments later.

Those who don’t meet standard lending criteria might also consider a low-doc home loan as an alternative.

Pros and cons of interest-only home loans in Australia

Short-term benefits of interest-only home loans

• Lower monthly repayments – Freeing up cash flow for other expenses or investments.
• Potential tax benefits – Investors may deduct interest payments, making it appealing for property investment.
• Increased affordability – Can make homeownership more accessible in the short term.

Disadvantages of interest-only home loans

• Higher overall interest costs – Since the principal isn’t reducing during the interest-only period, you’ll pay more interest over the life of the loan.
• Repayment shock – When the interest-only loan term ends, repayments rise significantly, which may strain finances.
• Slower equity growth – Because you’re not paying down the loan balance, it takes longer to build home equity.
  

Interest-only home loan FAQs

What’s the difference between an interest-only loan and a ‘principal and interest’ loan?

• Interest-only loan – Lower repayments at first, but higher total costs.
• Principal and interest loan – Higher initial repayments, but you build equity faster and pay less interest overall.

Cost comparison

Interest-only loans cost less in the short term but become more expensive later.

Principal and interest loans have steady payments and reduce the loan balance from day one.

Financial impact

Interest-only loans offer flexibility but require planning for higher repayments.

Principal and interest loans provide long-term stability and help you own your home sooner.

What’s an example of an interest-only loan?

Imagine you take out a $500,000 loan at a 5% interest rate:

• Interest-only period (e.g. first 5 years): You only pay interest, around $2,083 per month.
• After 5 years, your principal and interest kicks in. Repayments rise significantly since you now pay off both the interest and the original loan amount.

This loan structure can be beneficial in the short term. It requires careful financial planning to manage the higher repayments later.

Can I change my home loan to interest-only?

Yes, you can switch your home loan to interest-only, but it depends on your lender’s policies and your financial situation.

What to consider before switching:

Lender approval

Banks assess your income, loan-to-value ratio (LVR), and repayment history before approving a switch.

Potential fees

Some lenders charge loan modification fees or require a full refinancing process.

Higher long-term costs

While switching lowers repayments short term, you’ll pay more interest over the life of the loan.

Stricter criteria for owner-occupiers

Interest-only loans are easier to access for investors than for owner-occupiers.

If you're considering switching, speak with a mortgage broker to weigh up the pros and cons.

Do you end up paying more or the same with an interest-only loan?

Yes, you end up paying more with an interest-only home loan than a principal and interest loan.

But why?

Interest accumulates for longer

Since you’re not reducing the loan balance during the interest-only period, you pay interest on the full amount for a longer time.

Higher repayments later

Once the interest-only period ends, your home loan repayments increase significantly. This is because you now have a shorter time to pay off the principal.

More total interest paid

Over the life of the loan, the total interest paid is higher than if you had been reducing the principal from the start.

Find out more about the most common types of home loans here.

Is an interest-only home loan right for you?

Interest-only loans offer short-term flexibility with lower repayments. They are appealing to investors and borrowers needing financial breathing room. 

However, they come with higher long-term costs and the risk of repayment shock once the interest-only period ends.

Before choosing this option, consider your financial goals, future income stability, and ability to handle increased repayments later. If you're unsure whether an interest-only loan suits your situation, speaking with a mortgage broker can help you weigh the pros and cons.

Need expert advice? Contact Mortgage Broker Brisbane today! Call 1300 475 525 or reach out to our team online.