Interest Only vs Principal & Interest Home Loans: Complete Comparison

Overview

Choosing between an interest only (IO) and a principal and interest (P&I) home loan is one of the most important decisions borrowers face. Each structure has distinct advantages and trade-offs depending on your financial goals, whether you are an owner-occupier or investor, and how long you plan to hold the property.

How Each Loan Type Works

Principal and Interest (P&I)

With a P&I loan, each repayment covers both the interest charged on the outstanding balance and a portion of the principal (the amount you borrowed). In the early years, most of the repayment goes toward interest, but over time the principal component grows and the interest component shrinks. By the end of the loan term, the entire debt is repaid.

For example, on a $500,000 loan at 6% over 30 years, the monthly P&I repayment is approximately $3,000. In the first month, about $2,500 goes to interest and $500 to principal. Over time, this shifts until nearly all of the repayment reduces the principal.

Interest Only (IO)

With an IO loan, you only pay the interest charged on the loan for a set period — typically 1 to 5 years (up to 10 years for investors in some cases). During the IO period, you do not repay any principal, so the loan balance stays the same. When the IO period ends, the loan reverts to P&I repayments for the remaining term, and the repayments increase because you must now repay the full principal over a shorter period.

Using the same example, on a $500,000 loan at 6%, the IO repayment is approximately $2,500 per month — about $500 less than the P&I repayment. However, after the IO period ends, the P&I repayments on the remaining term will be higher than if you had chosen P&I from the start.

Who Uses Each Type?

Owner-Occupiers

Most owner-occupiers choose P&I loans because the goal is to pay off the mortgage and own the home outright. Lenders also generally offer lower interest rates for owner-occupier P&I loans (typically 0.25% to 0.50% lower than IO rates), making P&I the more cost-effective option.

Property Investors

Investors often prefer IO loans for several reasons:

• Cash flow: Lower repayments during the IO period free up cash for other investments or to cover holding costs.
• Tax deductions: In Australia, interest on an investment property loan is tax-deductible. Since the full repayment on an IO loan is interest, the entire amount is deductible during the IO period.
• Negative gearing strategy: Lower repayments combined with full interest deductibility can maximise the tax benefit of negative gearing.
• Capital allocation: Rather than paying down a non-deductible debt slowly, investors may prefer to direct surplus funds toward other income-producing assets.

Pros and Cons

P&I Pros

• You build equity in the property from day one
• Lower total interest cost over the life of the loan
• Typically lower interest rates from lenders
• Forced savings discipline — each repayment reduces your debt
• Loan is fully repaid at the end of the term

P&I Cons

• Higher monthly repayments, reducing cash flow
• Less flexibility to redirect funds elsewhere

IO Pros

• Lower repayments during the IO period, improving cash flow
• Full interest deductibility for investment properties
• Flexibility to direct surplus cash to other investments or pay down non-deductible debt first
• Can still make voluntary extra repayments on most IO loans

IO Cons

• You do not reduce the principal during the IO period — no equity is built through repayments
• Higher total interest cost over the life of the loan
• Repayments increase (often significantly) when the IO period ends
• Lenders charge higher interest rates for IO loans
• Regulatory scrutiny means tighter lending criteria for IO borrowers

Total Cost Comparison

The total cost difference between IO and P&I can be substantial. Consider a $500,000 loan at 6% over 30 years:

• P&I from day one: Total interest paid over 30 years is approximately $579,000.
• IO for 5 years, then P&I for 25 years: Total interest paid is approximately $643,000.

That is roughly $64,000 more in interest with the IO option — because the principal is not being reduced during the first 5 years, and the remaining P&I repayments are calculated over a shorter 25-year period.

The higher the IO period and the larger the loan, the greater the total cost difference. This is why IO loans are generally suited to borrowers with a specific strategic reason (such as tax optimisation for investors) rather than as a way to simply reduce repayments.

How to Decide

Choose P&I if:

• You are an owner-occupier wanting to pay off your home
• You want the lowest total cost over the life of the loan
• You prefer forced discipline in debt reduction
• You want the lowest available interest rate

Choose IO if:

• You are an investor optimising cash flow and tax deductions
• You have a clear plan for using the freed-up cash productively
• You understand and accept the higher total cost
• You can comfortably afford the higher repayments when the IO period ends

Modelling Your Options

Use our calculators to compare the two structures with your actual numbers:

• Mortgage Repayment Calculator — model P&I repayments at different rates and terms
• Loan Comparison Calculator — compare an IO loan against a P&I loan side-by-side
• Extra Repayments Calculator — see how making extra repayments on a P&I loan accelerates payoff

Compare loan structures: Loan Comparison Calculator | Calculate repayments: Mortgage Repayment Calculator.

Sources: ASIC Moneysmart, ATO — Rental Properties Guide, Canstar, RBA.