Principal & interest

What is a principal and interest loan?


When you make a home loan repayment, generally there’s a component that goes towards paying down the principal balance of the loan (the amount you borrowed) and a component that goes towards interest (the cost of borrowing). This is known as a principal and interest (P&I) repayment.

Interest only

What is an interest only loan?

Another option is to only pay the component that goes towards interest, for a specified period. This is known as an interest only repayment. For this period, you are not paying back any of the money you actually borrowed.


How long can I be on an interest only term?

Depending on your loan purpose and repayment type, there are a few different options available. However, these are subject to assessment and approval.

Variable Fixed
Owner Occupied
1-5 year terms 1-5 year terms
Investment
1-5 year terms
10 year term
1-5 year terms

If I wish to switch to an interest only term, what are some key things to consider?

Switching to interest only repayments does require an approval process. Here are a few things we need to look at:

  • your current financial situation
  • your future financial goals
  • why you wish to switch to interest only repayments.
The difference

The difference between interest only and principal and interest

It all comes down to what your repayments are used for and the effect that has on your ongoing repayments.

While the repayments over the initial interest only period would be lower (given no principal balance is being repaid yet), after the initial interest only period ends the loan would convert to principal and interest repayments. You will now have a shorter time period left to pay off the principal. As a result, the repayments are likely to be higher over the remaining term of the loan.


Interest only vs. principal and interest: An example

To get a clear picture of what a principal and interest vs interest only loan can mean in real terms, let’s put some figures to it.

Principal and interest loan

Sam has a $450,000 loan for an investment property. He plans to pay down some balance, move into the property in a few years’ time and then use some equity from this property to make a new investment property purchase.

Over the next three years, Sam pays down $30,000 off his loan through principal and interest repayments.

Interest only loan

Michelle also has a $450,000 loan an investment property. She prefers to make interest only payments initially to suit her tax arrangements. She may also sell her investment property in a few years’ time.

Over the next three years, Michelle only makes interest only payments and does not pay down any principal balance on her loan.

After three years, her repayments are higher as she must now begin making principal and interest repayments over the remaining term of the loan.

The pros and cons

Principle and interest home loan vs interest only home loan - the pros and cons

Pros Cons
Principal and interest
Depending on your current and long-term objectives, you may prefer principal and interest repayments over interest only. Although your repayments are typically more to begin with, some real financial benefits kick in over the life of your loan. It’s usually offered at a lower interest rate than an interest only loan, and you’ll pay less interest over the life of your loan (because you’re reducing the principal on which the interest is charged). And that means you’ll pay off your loan sooner. Paying principal and interest repayments is a greater cost up front.
Interest only

Interest only home loans can be a tempting option because initially they’re friendlier to your hip pocket as your repayments will be less.

It also may suit your tax arrangements and financial strategy if you’re an investor.

It’s important to consider that while repayments could be smaller during the interest only term, they could increase after the interest only term ends and you could end up paying more in interest over the life of the loan.

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