Interest Only

Plain-English definition. An interest-only (IO) loan is a mortgage where you pay only the interest charged each month for a set period, with no reduction in the loan principal. Repayments are lower, but the debt does not amortise.

How it works in Australia. APRA tightened IO lending in 2017 after IO loans peaked at 40% of new lending; today they sit around 15%. Most lenders cap IO terms at 5 years for owner-occupiers and 10 years for investors. After the IO period, the loan reverts to P&I — but over the remaining term, meaning repayments jump sharply (the "IO cliff"). IO loans are typically offered at rates 0.10–0.40% above equivalent P&I. They are most defensible for investors using negative gearing because interest is tax-deductible while principal repayments are not.

Concrete example. An investor borrows $600,000 at 6.40% IO for 5 years, then P&I for the remaining 25 years. IO repayment: $3,200/month. After 5 years, the principal is still $600,000 — they've paid $192,000 of pure interest. The P&I repayment over the remaining 25 years jumps to about $4,030/month — a 26% increase. By contrast, a P&I loan from day one would have repayments of $3,755 throughout and the balance at year 5 would be about $545,000.

Common confusion. Owner-occupiers are sold IO as a way to "afford a bigger house" — almost always a bad idea, since you defer principal repayment without tax benefit and face the cliff. The interest deduction depends on the loan's purpose (investment vs owner-occupier), not its structure (IO vs P&I), so structuring an owner-occupier loan as IO doesn't generate any tax advantage.