Investors

Interest-only vs principal-and-interest investment loans

How repayment type changes cash flow, debt reduction and the long-term cost of an investment property loan.

Short answer

Interest-only repayments cover interest for a set period but do not reduce the loan balance. Principal-and-interest repayments are higher initially because they also repay the debt. The better structure depends on cash flow, strategy, risk and total cost – not tax deductions alone.

Key trade-offs

Interest-only can preserve short-term cash flow, but the rate may be higher and repayments usually rise when the interest-only period ends. The remaining principal must then be repaid over a shorter period.

Interest-only: lower initial repayments and no automatic debt reduction.
Principal and interest: builds equity by reducing the balance.
Both options remain exposed to rate changes if variable.
Tax deductibility depends on how borrowed funds are used.

Compare the future repayment

Model the repayment after the interest-only term, total interest over the expected holding period and your ability to manage vacancies or rate rises. Obtain tax advice for your circumstances before choosing a structure for tax reasons.

Why repayments jump later

If a 30-year loan has five years of interest-only repayments, the original principal still needs to be repaid over the remaining 25 years. The repayment can increase even if the interest rate does not. APRA expects banks to assess the borrower's ability to meet principal-and-interest repayments over the actual remaining repayment period. Before choosing interest-only, calculate the later repayment at both the current rate and a higher rate.

Cash flow is not the same as profit

Lower initial repayments can improve holding cash flow, but the loan balance does not reduce through scheduled payments. If the property value falls or remains flat, equity may not grow. Principal-and-interest repayments build equity by reducing debt, but they require more cash each month. Compare the after-tax cash flow, total interest and expected balance at the point you may sell, refinance or finish the interest-only term.

Tax needs separate advice

Interest may be deductible when borrowed money is used to produce assessable income, but the security property does not decide deductibility by itself. Redrawing, mixing private and investment purposes or changing how funds are used can complicate tracing. A tax deduction also returns only part of an expense, so it does not make unnecessary interest beneficial. Ask a registered tax adviser about your structure, then choose a loan that remains affordable without relying on an uncertain future tax outcome.

Questions to ask before you proceed

How much verified rent will the lender use and which property expenses are included?
How are my existing investment debts and future principal repayments assessed?
Which parts of the proposed structure need separate registered tax advice?

Key takeaway

Choose the repayment type after comparing cash flow today with debt and repayments tomorrow.

Official guidance: Moneysmart: Interest-only home loans

This is general information, not personal financial, tax or legal advice. Lending criteria, fees and eligibility vary.

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