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What is an interest only home loan?

Home loan repayments are based on paying off two factors: the principal (loan amount owing) and the interest (rate set by the lender charged on the principal).

Most home loan repayments in Australia are designed to pay both the principal and interest each time. However, some lenders do allow homeowners the option of paying just the interest with their repayments, also known as an interest only home loan. By only paying for the interest charges on your home loan, your repayments are significantly reduced.

Home loans with interest only repayments are typically set to revert to principal and interest repayments after several years. This is because by only repaying interest charges, you’re not actually chipping away at your principal owing - meaning, your home loan debt is never actually being repaid.

How does an interest only home loan work?

Home loan terms are typically 25-30 years, and for however long you pay interest-only, you’re not actually reducing your principal owing. For a borrower that doesn’t sell a property for profit quickly, this means that eventually when your interest-only period ends, your repayments will be significantly higher.

This is because you’ve effectively just shortened your home loan term without reducing your debt.

For example, let’s take a 30-year, $350,000 home loan at a rate of 3%. If you were making principal and interest repayments, your monthly repayments would sit at $1,476. If you were paying interest only over a 5-year period, your monthly repayments would be $875. This is a savings, albeit a short-term, of $601 a month.

Principal and interest vs. interest only home loan repayments

P&I loanIO for 5 years
Monthly repayments during interest only period$1,476$875
Monthly repayments after interest only period$1,476$1,660
Total repayments made$531,221$550,422
Additional interest paid due to the interest-only period/$19,201

Source: RateCity.com.au. Note: Based on a hypothetical 30-year, $350,000 home loan at a rate of 3%. Figures used for example purposes only and do not factor in rate changes or fees.

However, at the end of the interest only period, the monthly repayments jump to $1,660. This is an increase of $184 a month compared to standard principal and interest repayments. Over a year, this is an increase of $2,208 in mortgage repayments – the equivalent of a yearly utilities bill or a family holiday.

Who uses interest only home loans?

Interest only repayments are lower than principal and interest repayments, so they are favoured by borrowers hoping to keep expenses down, typically investors looking to flip a property.

If you are an investor unlikely to keep a property for the full 25-30-year home loan term, then interest only repayments may be an option to consider. If principal and interest repayments on an investment property were, say, $2,000, but paying interest-only meant your monthly repayments were a few hundred dollars, your rate of return when you sell may be significantly higher.

Owner-occupiers may also be able to opt for interest only repayments. But, as owner-occupiers typically live in the home for the duration of the loan term, it may be beneficial to instead focus on repaying the principal amount owing. However, if a homeowner fell into financial stress and was struggling to repay the mortgage repayments, refinancing to an interest-only home loan may offer some financial relief. 

Just keep in mind that for however long your repayments are set to interest only, you are not paying down your mortgage debt. When the interest only period ends, you may find your repayments are higher than before due to your shortened loan term.  

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What are the benefits of interest only loans?

Before you choose your home loan repayment type, it’s worth comparing the benefits and risks of interest only repayments.

Benefits of interest only loans:

  • Lower repayments – The most significant benefit of interest only repayments are that it offers borrowers lower monthly repayments during the interest only period.
  • Higher rate of return – If you’re a property investor, opting for interest only repayments may offer you a higher rate of return on the property by reducing your ongoing mortgage expenses.
  • Free up cash – For owner-occupiers and investors alike, paying lower mortgage repayments may help free up some much-needed cash for other purposes.

What are the risks of interest only loans?

As with any financial product, there are risks worth considering when it comes to interest only home loan repayments.

Risks of interest only loans:

  • Higher ongoing repayments – As demonstrated above, once your interest only period ends, your repayments will increase considerably.
  • Pay more interest – By not repaying your loan principal owing for several years, you may pay additional interest over the life of the loan.
  • Risk of default – In 2017, the Australian Prudential Regulation Authority (APRA) ordered banks to reduce the number of interest only loans on their books to below 30%. This is because a considerable portion were interest only, meanwhile debts were not being repaid and borrowers were struggling with higher repayments once this interest only period ended. There is always a risk with interest only repayments that you may be unable to service the loan once this period ends and/or if your financial circumstances change.  

Can I change my home loan to interest only?

If you are unhappy with your home loan and want to switch to interest only repayments, you may have two options: speak to your current lender and/or consider refinancing.

Regardless of the path you take, you may need to meet certain eligibility criteria as you did when you first applied for the mortgage. This may include having an LVR of 80% or less, having good to excellent credit history and in a strong financial position.

How do I compare interest only loans?

One of the best ways to compare home loans is to use comparison tools, such as tables, calculators, and rating systems. At RateCity, we offer the following:

Comparison tables

Comparison tables, like the one on this page, may help you filter down your home loan options then compare them side by side. Sort your results by advertised rate, comparison rate or Real Time RatingsTM score, and create a shortlist of options that may suit your financial situation.

Home Loan Repayment Calculator

A Home Loan Repayment Calculator will calculate potential mortgage repayments based on different interest rates and repayment frequencies. This may help you to view how an interest only home loan’s repayments could suit your budget, allowing you to narrow down your options.

Real Time RatingsTM

To narrow down your shortlist of options, you may want to look at the Real Time RatingsTM score of each loan product. Real Time RatingsTM is RateCity’s world-first rating system that ranks home loans based on your individual requirements. Each product is given a score out of five, based on loan costs and flexibility. Unlike other comparison pages which rank their products once or twice a year, Real Time RatingsTM results are calculated live, so they are up to date as possible.

Mortgage Brokers

As interest only home loans may be more difficult to find, it may be worth speaking to a mortgage broker for expert advice and assistance finding your best loan option and filling out your loan application – without charge.

What are the features of interest only loans

When searching for your best interest only loan, there’s more to review than just the mortgage repayment type. Here are some of the key features to compare when applying for your first or next home loan:

  • Interest rate

The advertised interest rate is a significant cost associated with a home loan. The higher the interest rate, the more expensive your loan repayments potentially may be. Comparison rates may also help you compare home loans as they factor in the advertised rate and some fees, based on a 25-year, $150,000 home loan paying principal and interest. While this may not be entirely comparable with the home loan you’re searching for, it may help to better illustrate the true cost of a loan.

  • Revert rate

Interest only repayments last for a set period of time - typically up to 5 years. After this, the home loan interest rate will revert to principal and interest repayments on the lender’s standard variable rate. It’s worth familiarising yourself with this rate to prepare your budget when the interest only period ends.

  • Fees

Interest-only home loans can come with a range of fees that can add to the cost of the mortgage. This includes upfront fees like application fees and ongoing fees like annual fees.

  • Loan term

A typical home loan length is around 25 years but extending this term to 30-40 years may mean your monthly repayments are smaller, but the total interest you’ll pay over the life of the loan can climb significantly.

  • Features

Interest-only mortgages may include a range of features that make the loan more flexible and easier to repay, including an offset account, a redraw facility, and the ability to make extra repayments without charge.

Who offers interest only loans?

You may be able to apply for an interest only home loan from a range of Australian lenders, including the big four banks (Commonwealth Bank, Westpac, ANZ and NAB), as well as lenders like Bank Australia, Macquarie Bank and loans.com.au.

If you have an ideal lender in mind for your interest only home loan, click on more filters above the comparison table, find the lender’s field and enter its name here. You’ll potentially be shown one or more interest only home loan rates from that lender.

This article was reviewed by Head of Content Leigh Stark before it was published as part of RateCity's Fact Check process.