Interest Only vs Principal and Interest: Repayments Compared

The interest only vs principal and interest choice is about when you repay the debt, not just which monthly figure looks smaller. An interest-only period can reduce the required payment at first, but it leaves the principal to be repaid later. Understanding that later payment is essential before choosing the structure.

Quick answer

Principal-and-interest repayments reduce the loan balance as well as paying interest. Interest-only repayments leave the principal unchanged during the agreed period, usually creating higher repayments later because the debt must be repaid over the remaining term. Compare the full repayment schedule, rates and total interest, not just the initially smaller monthly payment.

Interest only vs principal and interest: what changes?

A principal-and-interest payment covers the interest charged and pays down part of the amount borrowed. Early in a long loan, interest makes up a large share of the payment, but the balance still reduces when the scheduled payments are made under the assumed rate and terms.

An interest-only payment covers the interest for the period without a scheduled reduction in principal. Moneysmart’s explanation highlights that the debt must then be repaid over the remaining term and that total interest can be higher.

The choice is separate from fixed versus variable interest rates. A loan can have a repayment type and a rate type at the same time. Our fixed versus variable guide explains the rate decision; it does not replace checking the principal repayment schedule.

An example with the same rate on both loans

Consider a hypothetical $600,000 loan over thirty years at a constant 6% annual interest rate, with monthly payments and no fees. Compare principal-and-interest repayments from the start with five years interest-only followed by principal-and-interest over the remaining twenty-five years.

These are calculations, not current loan offers. The model uses the standard monthly amortisation formula and assumes the rate never changes. Real lenders may calculate interest daily, round differently and charge fees. Interest-only and principal-and-interest products may also have different rates.

The first saving is not a reduction in debt

In the example, the interest-only payment is about $597 lower each month during the first five years. That can make the household cash flow feel more comfortable. However, the principal-and-interest borrower has reduced the balance by roughly $41,674 over the same period.

Neither figure should be considered alone. If the lower required payment is spent elsewhere, the interest-only borrower reaches year six with the original $600,000 still owing. If it is saved or used for another purpose, assess that actual strategy and its risks rather than assuming the money creates an automatic benefit.

Avoid describing the initial payment difference as “savings” without qualification. It is partly a postponement of debt repayment. A useful comparison follows both the bank-account cash flow and the outstanding mortgage balance.

The repayment jump has two comparisons

For the interest-only borrower in the example, the payment rises from $3,000 to about $3,866: an increase of roughly $866 a month. Compared with the borrower who paid principal from the start, the later payment is about $269 higher each month.

Those numbers answer different questions. The first describes the household’s budget shock at the transition. The second compares the two structures after the initial period. Both can matter when deciding whether the arrangement is sustainable.

A rate increase would change the result again. Ask the lender for the scheduled transition payment at the current applicable rate and at a higher rate. Do not budget solely from the interest-only amount shown most prominently in a quote.

Total interest belongs in the decision

Under the same-rate assumptions, the interest-only structure adds about $44,713 in total interest over thirty years. This is not a forecast for every loan. It isolates the effect of leaving the principal outstanding for longer under a simple model.

If the interest-only rate is higher, or the loan has extra fees, the difference can be larger. If you make permitted extra repayments or use an eligible offset, the outcome may change. Model the actual product rather than applying the illustration as a universal result.

Use Moneysmart’s interest-only calculator with your own proposed balance, term and rates. Save the assumptions alongside the result so another person can understand how it was calculated. A calculator output without its inputs is difficult to compare meaningfully.

When a lower initial payment is being considered

There may be reasons a borrower discusses interest-only repayments with a lender or adviser, including a particular investment or cash-flow strategy. The relevant question is whether the full arrangement suits the circumstances, not whether one repayment type is universally good or bad.

Ask what the freed cash will actually do, how the later payment will be funded and what happens if the expected income or investment return does not arrive. If the proposal depends on continuous property-price growth, it needs a more cautious assessment.

Tax treatment is separate from repayment affordability. Do not assume that investment borrowing is automatically deductible in every circumstance or that a tax deduction makes higher interest cost desirable. Seek qualified advice about the intended use of funds and the overall strategy.

Check features and restrictions

Ask whether extra principal repayments are permitted during the interest-only period and whether limits or charges apply. Fixed-rate terms can restrict extra payments. Also check how a payment affects future instalments, available redraw and the remaining balance.

An offset account is not the same as repaying principal. Its benefit depends on the eligible balance and product terms. Our offset-account value guide explains why fees and the amount you actually keep in the account matter.

Compare the whole loan using Moneysmart’s selection guidance: rate, fees, flexibility and term. A repayment structure that looks appealing can be paired with features you do not need or costs that reduce its usefulness.

Do not build the exit around a guaranteed refinance

Refinancing later requires a new assessment. Income, expenses, property value and lending policy may all be different when the interest-only period ends. The lender is not obliged to provide another interest-only period simply because the first one was approved.

If your plan is to sell, consider sale costs, timing and the possibility of a lower price. A sale is not an instant or guaranteed way to clear the debt. If your plan is to refinance, include switching costs and test whether the original repayment schedule remains affordable without it.

Our refinancing-cost guide provides a separate checklist. Do not repeatedly extend the overall loan term without understanding the additional interest and how long the debt will remain outstanding.

Put both schedules on the same timeline

When comparing quotes, use the same starting balance and total term. Mark the interest-only end date, any fixed-rate expiry and the date a discount ends separately. These dates need not coincide, and several changes close together can make the household impact harder to see.

Ask for the amount owing at each milestone as well as the payment. If one quote assumes a refinance or term extension halfway through, label that assumption explicitly instead of comparing it with an uninterrupted thirty-year schedule. Keep any tax estimate outside the basic loan arithmetic so the financing costs remain transparent.

Prepare before the interest-only period ends

Check the end date, estimated new repayment and any action the lender requires. Update the household budget early. If possible, test living with the higher payment amount before it starts, while following the loan’s rules for any extra payments.

If the figure is unaffordable, contact the lender promptly about the circumstances and available assistance. Waiting until the first missed payment reduces the time to work through options. A financial counsellor can help with the wider budget if several debts are involved.

General information checked 29 September 2026. The example is an original calculation using stated assumptions, not personal financial, credit or tax advice. Obtain an assessment tailored to your circumstances before choosing or changing a repayment structure.