In short: An interest-only (IO) loan lets you pay just the interest for a set period, usually one to five years, so repayments are lower and the balance does not move. When the period ends the loan reverts to principal and interest over the remaining term, so repayments jump. Investors use IO for cashflow and tax; owner-occupiers use it rarely and briefly.
Interest-only sounds like a cheaper loan. It is not. It is the same loan with the principal repayments postponed, and every dollar you skip now has to be repaid faster later, with more total interest along the way. That trade-off is worth making in some situations, particularly for investors with non-deductible home debt, and a poor idea in others. This guide walks through how IO works in practice, what lenders assess, the tax angle, and a Point Cook example with real numbers so you can see the effect over 30 years.
How an interest-only period works
A standard home loan is principal and interest (P&I): each repayment covers the month's interest plus a slice of the balance, so the loan is gone by the end of the term. An IO loan splits the term in two.
The IO period
During the IO period, typically 1 to 5 years for owner-occupiers and up to 5 years (occasionally 10 in total across renewals) for investors, you pay only the interest charged each month. On a $600,000 loan at 6.00% p.a. for illustration, that is $3,000 a month. The balance stays at $600,000 for the whole period unless you make extra repayments or hold cash in an offset account.
The reversion
When the IO period ends, the loan does not become a fresh 30-year P&I loan. It reverts to P&I over whatever term is left. A 30-year loan with a 5-year IO period has 25 years remaining, so the full $600,000 has to be repaid in 25 years instead of 30. Repayments rise for two reasons at once: you start repaying principal, and you are doing it over a shorter term. Borrowers call this the "IO cliff", and it catches out anyone who has not planned for it.
The numbers on a $600,000 loan
| $600,000 loan, 6.00% p.a. for illustration | Monthly repayment | Total interest over the life of the loan |
|---|---|---|
| P&I from day one, 30 years | $3,597 | about $695,000 |
| Interest-only period (years 1 to 5) | $3,000 | |
| P&I after IO, 25 years remaining | $3,866 | |
| 5 years IO then 25 years P&I, combined | $3,000 then $3,866 | about $739,700 |
| Extra cost of the IO structure | about $44,700 |
The $597 a month you save during the IO years becomes a repayment $269 a month higher than the straight P&I loan for the following 25 years, and the loan costs roughly $44,700 more in interest overall. You can test your own figures in the interest-only vs principal and interest calculator.
Who uses interest-only loans
Investors
Most IO lending in Australia is on investment property loans, and the logic is cashflow plus tax. Interest on a loan used to buy an income-producing property is tax deductible; the principal component of a P&I repayment is not. Paying IO keeps the deductible balance high and frees up cash that can go towards non-deductible debt (your own home) or into an offset account, where it stays accessible. The investment property guide covers the wider strategy, and negative gearing explained shows how the deductions flow through your tax return.
Owner-occupiers, occasionally
Lenders are wary of IO for owner-occupiers because it does not build equity, and APRA has pushed banks to limit it. It still has legitimate short-term uses:
- Construction loans, where you usually pay interest only on the amount drawn while the house is built.
- Parental leave or a planned drop in income for a year or two.
- Bridging finance, where you carry two properties for a few months. See bridging loans.
- A temporary hardship arrangement agreed with the lender.
If you are an owner-occupier considering IO purely to afford a bigger loan, that is a warning sign rather than a strategy.
What lenders look at
Rate and LVR
IO loans typically carry a higher interest rate than the equivalent P&I loan, and the gap is wider for owner-occupiers than investors. Maximum LVR is often lower too: many lenders cap owner-occupier IO at 80% and investor IO at 80% to 90%, where P&I might go to 95%.
Serviceability on the reduced term
This is the part that surprises people. When a lender assesses whether you can afford an IO loan, it does not use the IO repayment. It calculates the P&I repayment over the remaining term after the IO period, at your rate plus the 3 percentage point APRA buffer. On a $600,000 loan with a 5-year IO period, the assessment uses a 25-year P&I repayment at 9.00% (roughly $5,030 a month) rather than the 30-year figure (roughly $4,830). A shorter assessed term means a higher assessed repayment, which cuts your borrowing power. Run the borrowing power calculator both ways to see the difference on your income.
Extending or renewing the IO period
An IO period does not roll over automatically. Some lenders let you apply for a further IO term before the current one ends, but it is a new credit assessment under the responsible lending rules of the National Consumer Credit Protection Act: current income, current expenses, current rate plus buffer, and often a fresh valuation. If your circumstances have changed, or lender policy has tightened, the answer can be no, and the loan reverts to P&I whether or not that suits you. Treat the IO expiry date like a fixed-rate expiry: diarise it 6 months out and get advice early.
The tax angle
Interest on an investment loan is deductible whether the loan is IO or P&I. IO does not create a deduction; it preserves one. Consider a Melbourne household with a $400,000 owner-occupier loan (interest not deductible) and a $600,000 investment loan (interest deductible). Every dollar of principal they pay off the investment loan reduces a deductible balance. Every dollar they put against the home loan, or into an offset attached to it, reduces a non-deductible balance. Paying IO on the investment property and directing the difference at the home debt is the more tax-efficient order.
Two cautions. First, keep loan purposes separate: mixing personal and investment borrowing in one account muddies the deduction. Second, an offset account is usually better than redraw for this strategy, because withdrawing redraw from an investment loan for personal use can taint its deductibility. The offset vs redraw guide explains why, and the offset calculator shows the interest saved.
Worked example: a Point Cook investor
Anika and Rohan live in Point Cook with a $350,000 loan on their home. They buy a $750,000 investment townhouse nearby with a 20% deposit and a $600,000 investment loan, for illustration at 6.00% p.a. It rents for $560 a week, about $29,100 a year.
| Year 1 comparison | Interest-only | Principal and interest |
|---|---|---|
| Monthly repayment | $3,000 | $3,597 |
| Annual repayments | $36,000 | $43,164 |
| Deductible interest (approx.) | $36,000 | $35,700 |
| Rent received | $29,100 | $29,100 |
| Cash shortfall before rates, insurance and management | $6,900 | $14,064 |
The deductions are almost identical. What differs is the $7,164 a year of cash. Anika and Rohan put that difference into the offset account attached to their $350,000 home loan. After 5 years they have about $35,800 sitting in the offset, cutting non-deductible interest on their own home every day while the investment loan's deductible balance stays at $600,000.
At the end of year 5 the investment loan reverts to P&I at $3,866 a month. They have three choices: absorb the higher repayment (rent has likely risen), apply for a new IO period through a fresh assessment, or refinance the investment loan to a new 30-year term with another lender, which resets the repayment to about $3,597 at the same rate. The refinancing guide explains that process. Our Point Cook mortgage broker page covers the lenders active in the area.
Checklist before you choose interest-only
- You know the exact date the IO period ends and what the P&I repayment will be from that date.
- You have run the numbers on the reversion repayment at a rate 2 to 3 percentage points higher than today's.
- The purpose is clear: investment cashflow, construction, a defined short-term income gap, not simply a bigger loan.
- Investment and personal borrowings sit in separate loan accounts.
- The cash you free up has a job (offset on non-deductible debt, extra repayments elsewhere), not a lifestyle.
- You have compared the IO rate against the P&I rate at the same lender and at competitors.
- You understand that a further IO period is not guaranteed.
- Your accountant has confirmed how the interest will be treated for tax.
Common mistakes
Treating the IO repayment as the real cost. The $3,000 a month is a holiday, not the price. Budget on the $3,866 reversion figure.
Spending the difference. IO only makes sense if the freed cash is working somewhere. If it simply lifts your spending, you have paid $44,700 extra interest for nothing.
Assuming the IO period will be extended. Policy tightens, incomes change, valuations fall. Plan for reversion as the default.
Using IO to stretch into a bigger owner-occupied purchase. Lenders assess you on the P&I reversion anyway, and the higher rate and lower LVR cap usually make it worse, not better.
Redrawing from the investment loan for personal spending. It can reduce the deductible portion of the interest permanently. Use an offset.
Ignoring the rate premium. A 0.20 to 0.40 percentage point loading on $600,000 is $1,200 to $2,400 a year. It should be part of the comparison.
Frequently asked questions
Is interest-only good for an investment property?
Often, yes, if you have non-deductible home debt or want to keep cash accessible. IO keeps the deductible investment balance high while you direct spare cash to your own home loan or offset. It costs more total interest on the investment loan and does not build equity by itself, so it suits investors with a clear plan for the freed-up cash and a strategy for the reversion, not everyone.
Can owner-occupiers get interest-only?
Yes, but with tighter limits. Most lenders offer owner-occupier IO periods of 1 to 5 years, usually at a higher rate and a maximum LVR of about 80%. You will need a reason the lender accepts, such as construction, parental leave or bridging between properties. Serviceability is assessed on the P&I repayments over the shorter remaining term, so it does not help you borrow more.
What happens when interest-only period ends?
The loan automatically reverts to principal and interest over the remaining term. On a $600,000 30-year loan with a 5-year IO period, repayments move from $3,000 to $3,866 a month at 6.00% p.a. for illustration, because the full balance must now be repaid in 25 years. Lenders write to you before the change. If the new repayment is a problem, talk to your broker about a new IO period or a refinance before it happens.
Can I extend my interest-only period?
Sometimes. You can apply for a further IO term before the current one expires, but it is treated as a new application: the lender reassesses income, expenses and often the property value under current policy. Approval is not guaranteed, and total IO time is usually capped at 5 to 10 years across all periods. If your lender declines, refinancing to another lender that offers a fresh IO period is the usual alternative.
Is interest-only cheaper?
Only month to month during the IO period. Over the life of the loan it is more expensive: the balance does not reduce during the IO years, and the interest rate is usually higher than the P&I equivalent. On a $600,000 loan at 6.00% p.a. for illustration, 5 years IO then 25 years P&I costs about $739,700 in interest versus about $695,000 for P&I throughout, a difference of roughly $44,700.
Does interest-only reduce borrowing power?
Yes. Lenders assess an IO loan on the P&I repayment over the term left after the IO period, at your rate plus a 3 percentage point buffer. A 25-year assessed term produces a higher repayment than a 30-year one, so your maximum loan is lower. The higher IO rate widens the gap. If borrowing capacity is tight, ask your broker to model the application both ways before you decide.
Talk to GNT Finance
Gorakh Timilsina spent years as a senior credit officer assessing exactly these applications, so he knows how each lender treats IO periods, reduced-term serviceability and rollovers, and where the sensible structure for a Melbourne investor lies. GNT Finance compares IO and P&I options across our lender panel, and there is no cost to you for our home-loan service in most cases. Book a free consultation or call 0426 403 703.
This page is general information only and not legal, tax or financial advice. Laws change — confirm current rules with the State Revenue Office, the ATO or a licensed professional.
Written by Gorakh Timilsina
Founder, CEO & Senior Mortgage Consultant at GNT Finance. Gorakh started as a broker assistant, spent years as a senior credit officer assessing loan applications, and now helps Melbourne families get the right loan approved. English, Nepali and Hindi spoken.