What are interest-only loans?

Most mortgages are principal and interest loans. In these loans, you pay back the money you’ve borrowed (the principal) and your interest charges at the same time.

In an interest-only loan, you only pay your home loan’s interest charges, without reducing the amount you owe. 

Generally, interest-only loans last for a maximum of five years, though some lenders will allow you to extend the interest-only period. After this, the loan will automatically revert to a principal and interest loan.

How do interest-only loans work?

Imagine you want to buy a $440,000 property. You could borrow $350,000 at an interest rate of 5 per cent, and make monthly repayments for 30 years.

If you had a principal and interest loan, you would have to pay $1,879 per month. Of that amount, $1,458 would be interest, while the other $421 would go towards reducing the principal.

After one month, the amount owing on your mortgage would drop from $350,000 to $349,579. After two months, it would drop to $349,158.

If you had an interest-only loan, you would have to pay just $1,458 per month. This would be nothing but interest, so your outstanding mortgage would remain at $350,000.

After 5 years of paying interest only, you would have 25 years to repay your $350,000 principal, which would require monthly repayments of $2,046.

If you paid interest only on your mortgage for five years, followed by 25 years of principal and interest payments, your total cost would be $701,320. But if you made principal and interest payments for 30 years, your total cost would be $676,395. That’s a difference of $24,924.

This difference would be even larger if your interest-only period lasted for 10 or 15 years:

Scenario P&I Loan IO for 5 years IO for 10 years IO for 15 years
Monthly repayments during interest-only period $1,879 $1,458 $1,458 $1,458
Monthly repayments after interest-only period $1,879 $2,046 $2,310 $2,768
Total repayments made $676,395 $701,320 $729,363 $760,700
Additional interest paid due to interest-only period $0 $24,924 $52,968 $84,305

Source: MoneySmart

interest only

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Product
Advertised Rate
Comparison Rate*
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Monthly Repayment
Features
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Go to site

3.59%

Variable

3.49%

Athena Home Loans

$898

Redraw facility
Offset Account
Borrow up to 80%
Extra Repayments
Interest Only
Owner Occupied

4.22

/ 5
More details

3.59%

Variable

3.24%

Athena Home Loans

$898

Redraw facility
Offset Account
Borrow up to 80%
Extra Repayments
Interest Only
Owner Occupied

4.22

/ 5
More details

4.47%

Variable

4.66%

Pepper

$1.1k

Redraw facility
Offset Account
Borrow up to 65%
Extra Repayments
Interest Only
Owner Occupied

3.42

/ 5
More details

4.66%

Variable

4.85%

Pepper

$1.2k

Redraw facility
Offset Account
Borrow up to 80%
Extra Repayments
Interest Only
Owner Occupied

3.18

/ 5
More details

4.70%

Variable

4.72%

Heritage Bank

$1.2k

Redraw facility
Offset Account
Borrow up to 85%
Extra Repayments
Interest Only
Owner Occupied

3.17

/ 5
More details

3.99%

Variable

3.98%

Virgin Money

$998

Redraw facility
Offset Account
Borrow up to 80%
Extra Repayments
Interest Only
Owner Occupied

3.94

/ 5
More details

3.59%

Variable

3.64%

SCU

$898

Redraw facility
Offset Account
Borrow up to 95%
Extra Repayments
Interest Only
Owner Occupied

4.80

/ 5
More details

3.96%

Variable

3.89%

UBank

$990

Redraw facility
Offset Account
Borrow up to 80%
Extra Repayments
Interest Only
Owner Occupied

3.87

/ 5
More details

4.84%

Variable

4.89%

Heritage Bank

$1.2k

Redraw facility
Offset Account
Borrow up to 90%
Extra Repayments
Interest Only
Owner Occupied

2.86

/ 5
More details

5.21%

Variable

5.38%

Heritage Bank

$1.3k

Redraw facility
Offset Account
Borrow up to 85%
Extra Repayments
Interest Only
Owner Occupied

2.15

/ 5
More details

Learn more about home loans

What are the pros and cons of interest-only loans?
  • Enjoy more money in your budget for a limited time
  • Buy a property sooner
  • Negative-gear an investment property
  • Being in debt for longer
  • Jump in repayments when loan reverts to principal and interest
  • Loan costs more in total

Why do people use interest-only loans?

Many people apply for interest-only loans so they can pay less during the interest-only period. This can reduce the pressure on their budget and help them better manage their money.

Here are a few more reasons why an interest-only home loan may be worth considering:

Repay other debts with higher interest rates

Starting your mortgage with an interest-only term could be smart if you also have other debts to repay. Especially if these debts charge higher interest rates than your home loan.

For example, you could use the money you save on your interest-only home loan to help you pay off a car loan, a personal loan or a credit card. All of these debts typically have higher interest rates than a mortgage.

However, this strategy could backfire if you don’t manage to repay the other debts by the time your interest-only period expires. You may also struggle if you can’t afford the higher principal and interest repayments.

Enter the property market sooner

If you’re a young first home buyer, you might not be able to afford principal and interest payments on a property. However, you might be able to afford a mortgage if you only had to pay the interest for the first five years.

Sure, you’d have to pay more money over the life of the mortgage. But if you waited to enter the property market until you could afford to pay principal and interest, property prices could rise. This means you could end up paying more than you wanted to anyway.

Plus, by the time your mortgage reverts to principal and interest, your income may be higher. This could let you more easily afford the increased repayments.

However, it’s also possible your chosen property’s price won’t rise significantly during the interest-only period. Plus, you may still be unable to afford higher repayments at the end of the interest-only period. Keep this in mind before making a decision.

Benefit from capital growth and negative gearing

Imagine using an interest-only loan to enter the market sooner, but this time with an investment property.

Now imagine the value of this investment increasing by 10 per cent during the interest-only period. You may earn more in capital growth than you’d pay in interest charges.

For example, a $440,000 property’s value could climb to $484,000 in five years. With an interest-only loan, you’d pay an extra $24,924 in repayments, but gain an extra $44,000 in equity.

Negative gearing could let you use some of the interest payments on your investment property to reduce your taxable income. This could let you enjoy other tax benefits.

However, this strategy could backfire if your property doesn’t grow in value during the interest-only period. You also risk being unable to afford the higher repayments once it ends.

What are the risks of interest-only loans?

When you have an interest-only loan, your mortgage doesn’t decrease during the interest-only period. This means you may be in debt for longer, and pay more money over the life of your loan.

Once you move from interest-only to principal and interest, your repayments will be higher than if you’d been on principal and interest all along. That could cause problems if your financial position hasn’t improved during the interest-only period, and you can’t afford your loan.

Some lenders consider interest-only loans to be riskier than other home loans. This is because it's more likely someone could borrow more today than they can afford to repay in the future. This means some lenders place tighter restrictions on interest-only loans than on other home loans.

Before you apply for an interest-only loan, be sure to check its terms and conditions. You may also want to contact a financial counsellor to get advice on if an interest-only loan would be right for you.

How do I compare interest-only loans?

To compare interest-only loans, you could start by looking at the following:

Advertised interest rate

The advertised interest rate is an obvious place to start when comparing interest-only mortgages.

While most people look for home loans with the lowest interest rates, there is much more to consider.

Revert rate

Once your interest-only period ends, your mortgage will revert to a principal and interest (P&I) home loan. Lenders often charge different interest rates for P&I mortgages than for interest-only mortgages. Compare these ‘revert rates’ when doing your research.

Fees

Like other mortgages, interest-only home loans may charge a range of fees that can increase their cost. Sometimes a loan with a low interest rate and high fees can cost more in total than one with a high interest rate and low fees.

You may be asked to pay upfront fees when you apply, ongoing monthly/annual fees during the loan, or fees for using some of the loan’s special features.

Comparison rate

A home loan’s comparison rate combines its advertised rate with its main fees. This can give you a better idea of the loan’s total cost than the advertised rate alone.

Features

Interest-only mortgages may include features that make them more flexible and easier to repay. These may include:

  • Extra repayments: Paying more money onto your mortgage can reduce the principal you owe. This can reduce your interest charges and help you exit your loan sooner.
  • Redraw facility: Allows you to ‘borrow back’ (or redraw) any extra repayments you’ve made.
  • Offset account: A savings or transaction account linked to your mortgage. Money in this account is included when calculating your interest charges. For example, if you have a $500,000 mortgage and an offset account balance of $20,000, you’ll be charged interest on $480,000 rather than $500,000. This can help reduce your interest charges while offering easier access to your money.
  • Split rate: An option to divide your mortgage into two loans if you can’t decide between a variable or fixed rate. One loan would have a variable rate and the other would have a fixed rate.
  • Repayment holiday: Some lenders will allow you to pause your interest-only mortgage repayments to help you manage a major life event, such as a pregnancy. However, when your repayment holiday ends, your monthly repayments will probably increase. This is so your home loan is still paid off according to the original schedule.

Frequently asked questions

What is an interest-only loan? (include how do I work out interest-only loan repayments)

An ‘interest-only’ loan is a loan where the borrower is only required to pay back the interest on the loan. Typically, banks will only let lenders do this for a fixed period of time – often five years – however some lenders will be happy to extend this.

Interest-only loans are popular with investors who aren’t keen on putting a lot of capital into their investment property. It is also a handy feature for people who need to reduce their mortgage repayments for a short period of time while they are travelling overseas, or taking time off to look after a new family member, for example.

While moving on to interest-only will make your monthly repayments cheaper, ultimately, you will end up paying your bank thousands of dollars extra in interest to make up for the time where you weren’t paying off the principal.

How can I calculate interest on my home loan?

You can calculate the total interest you will pay over the life of your loan by using a mortgage calculator. The calculator will estimate your repayments based on the amount you want to borrow, the interest rate, the length of your loan, whether you are an owner-occupier or an investor and whether you plan to pay ‘principal and interest’ or ‘interest-only’.

If you are buying a new home, the calculator will also help you work out how much you’ll need to pay in stamp duty and other related costs.

Mortgage Calculator, Repayment Type

Will you pay off the amount you borrowed + interest or just the interest for a period?

What is principal and interest'?

‘Principal and interest’ loans are the most common type of home loans on the market. The principal part of the loan is the initial sum lent to the customer and the interest is the money paid on top of this, at the agreed interest rate, until the end of the loan.

By reducing the principal amount, the total of interest charged will also become smaller until eventually the debt is paid off in full.

What is the best interest rate for a mortgage?

The fastest way to find out what the lowest interest rates on the market are is to use a comparison website.

While a low interest rate is highly preferable, it is not the only factor that will determine whether a particular loan is right for you.

Loans with low interest rates can often include hidden catches, such as high fees or a period of low rates which jumps up after the introductory period has ended.

To work out the best value for money, have a look at a loan’s comparison rate and read the fine print to get across all the fees and charges that you could be theoretically charged over the life of the loan.

Interest Rate

Your current home loan interest rate. To accurately calculate how much you could save, an accurate interest figure is required. If you are not certain, check your bank statement or log into your mortgage account.

What happens to my home loan when interest rates rise?

If you are on a variable rate home loan, every so often your rate will be subject to increases and decreases. Rate changes are determined by your lender, not the Reserve Bank of Australia, however often when the RBA changes the cash rate, a number of banks will follow suit, at least to some extent. You can use RateCity cash rate to check how the latest interest rate change affected your mortgage interest rate.

When your rate rises, you will be required to pay your bank more each month in mortgage repayments. Similarly, if your interest rate is cut, then your monthly repayments will decrease. Your lender will notify you of what your new repayments will be, although you can do the calculations yourself, and compare other home loan rates using our mortgage calculator.

There is no way of conclusively predicting when interest rates will go up or down on home loans so if you prefer a more stable approach consider opting for a fixed rate loan.

How long should I have my mortgage for?

The standard length of a mortgage is between 25-30 years however they can be as long as 40 years and as few as one. There is a benefit to having a shorter mortgage as the faster you pay off the amount you owe, the less you’ll pay your bank in interest.

Of course, shorter mortgages will require higher monthly payments so plug the numbers into a mortgage calculator to find out how many years you can potentially shave off your budget.

For example monthly repayments on a $500,000 over 25 years with an interest rate of 5% are $2923. On the same loan with the same interest rate over 30 years repayments would be $2684 a month. At first blush, the 30 year mortgage sounds great with significantly lower monthly repayments but remember, stretching your loan out by an extra five years will see you hand over $89,396 in interest repayments to your bank.

How much are repayments on a $250K mortgage?

The exact repayment amount for a $250,000 mortgage will be determined by several factors including your deposit size, interest rate and the type of loan. It is best to use a mortgage calculator to determine your actual repayment size.

For example, the monthly repayments on a $250,000 loan with a 5 per cent interest rate over 30 years will be $1342. For a loan of $300,000 on the same rate and loan term, the monthly repayments will be $1610 and for a $500,000 loan, the monthly repayments will be $2684.

How do I calculate monthly mortgage repayments?

Work out your mortgage repayments using a home loan calculator that takes into account your deposit size, property value and interest rate. This is divided by the loan term you choose (for example, there are 360 months in a 30-year mortgage) to determine the monthly repayments over this time frame.

Over the course of your loan, your monthly repayment amount will be affected by changes to your interest rate, plus any circumstances where you opt to pay interest-only for a period of time, instead of principal and interest.

What happens if I don’t know my monthly repayments?

Your repayments should appear on your bank statements or your internet banking. If you make weekly or fortnightly repayments, make sure you convert them to monthly calculations.

What is a guarantor?

A guarantor is someone who provides a legally binding promise that they will pay off a mortgage if the principal borrower fails to do so.

Often, guarantors are parents in a solid financial position, while the principal borrower is a child in a weaker financial position who is struggling to enter the property market.

Lenders usually regard borrowers as less risky when they have a guarantor – and therefore may charge lower interest rates or even approve mortgages they would have otherwise rejected.

However, if the borrower falls behind on their repayments, the lender might chase the guarantor for payment. In some circumstances, the lender might even seize and sell the guarantor’s property to recoup their money.

What is the difference between a fixed rate and variable rate?

A variable rate can fluctuate over the life of a loan as determined by your lender. While the rate is broadly reflective of market conditions, including the Reserve Bank’s cash rate, it is by no means the sole determining factor in your bank’s decision-making process.

A fixed rate is one which is set for a period of time, regardless of market fluctuations. Fixed rates can be as short as one year or as long as 15 years however after this time it will revert to a variable rate, unless you negotiate with your bank to enter into another fixed term agreement

Variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts however fixed rates do offer customers a level of security by knowing exactly how much they need to set aside each month.

What happens to your mortgage when you die?

There is no hard and fast answer to what will happen to your mortgage when you die as it is largely dependent on what you have set out in your mortgage agreement, your will (if you have one), other assets you may have and if you have insurance. If you have co-signed the mortgage with another person that person will become responsible for the remaining debt when you die.

If the mortgage is in your name only the house will be sold by the bank to cover the remaining debt and your nominated air will receive the remaining sum if there is a difference. If there is a turn in the market and the sale of your house won’t cover the remaining debt the case may go to court and the difference may have to be covered by the sale of other assets.  

If you have a life insurance policy your family may be able to use some of the lump sum payment from this to pay down the remaining mortgage debt. Alternatively, your lender may provide some form of mortgage protection that could assist your family in making repayments following your passing.

What is a bad credit home loan?

A bad credit home loan is a mortgage for people with a low credit score. Lenders regard bad credit borrowers as riskier than ‘vanilla’ borrowers, so they tend to charge higher interest rates for bad credit home loans.

If you want a bad credit home loan, you’re more likely to get approved by a small non-bank lender than by a big four bank or another mainstream lender.

What is an ongoing fee?

Ongoing fees are any regular payments charged by your lender in addition to the interest they apply including annual fees, monthly account keeping fees and offset fees. The average annual fee is close to $200 however there are almost 2,000 home loan products that don’t charge an annual fee at all. There’s plenty of extra costs when you’re buying a home, such as conveyancing, stamp duty, moving costs, so the more fees you can avoid on your home loan, the better. While $200 might not seem like much in the grand scheme of things, it adds up to $6,000 over the life of a 30 year loan – money which would be much better off either reinvested into your home loan or in your back pocket for the next rainy day.

Example: Anna is tossing up between two different mortgage products. Both have the same variable interest rate, but one has a monthly account keeping fee of $20. By picking the loan with no fees, and investing an extra $20 a month into her loan, Josie will end up shaving 6 months off her 30 year loan and saving over $9,000* in interest repayments.

Should I become a guarantor?

You should carefully weigh up the pros and cons before signing on as a guarantor – because while it can be very rewarding if everything goes according to plan, it can have serious consequences if the plan goes awry.

If the person you’re guaranteeing keeps up with their mortgage repayments, you’ll be able to take pleasure in helping them fulfil their dream of home ownership.

However if that person fails to meet their mortgage repayments, it might damage or destroy your relationship. Your finances might also be affected if the lender asks you to make the repayments or even seizes your home to settle the debt.

How does RateCity make money?

For details on how RateCity makes money, please see here.

Can I enter more than once?

You can only enter the draw for the chance to win $1 million once. However, you can get additional entries by inviting your friends to check their own home loan rates. 

When you complete your initial entry, you’ll receive a unique URL that you can send to your friends. For each friend that checks their home loan rates using this URL, you’ll receive one additional entry into the draw. 

How is the flexibility score calculated?

Points are awarded for different features. More important features get more points. The points are then added up and indexed into a score from 0 to 5.