When it comes to choosing the right loan for you, a good place to start is deciding between an Interest only vs Principal and Interest home loan. But what exactly are they and what’s the difference? Let’s take a look.
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 repayment.
An Interest Only home loan means you only repay the monthly interest on the amount borrowed for a set term of one to five years. No repayments are required to reduce the principal amount borrowed, which means the loan balance doesn't reduce.
At the end of the Interest Only period, the loan will change to a 'Principal and Interest' loan and you'll start repaying the amount borrowed, as well as interest on that amount. Your loan repayments will be higher for the remainder of the loan term than they would have been if you had made Principal and Interest repayments from the beginning of the loan, because you will have less time left in the loan term to pay off the principal amount.
Learn about interest only home loans
It all comes down to what your repayments are used for and the effect that has on your ongoing repayments.
While your repayments during an initial Interest Only period will be lower (given no principal balance is being repaid), after the initial Interest Only period ends, the loan will convert to Principal and Interest repayments. You will now have a shorter time period left to pay off the principal. As a result, your repayments are likely to be higher over the remaining term of the loan.
To get a clear picture of what a Principal and Interest vs Interest Only home loan can mean in real terms, let’s put some figures to it.
Tom has a $450,000 owner occupier loan and wants to pay down his loan balance so he can build up some equity.
Tom pays monthly Principal and Interest repayments of $1,897.
Over the next three years, Tom:
Anna has a $450,000 investor loan and only wants to make interest repayments.
Anna pays only the monthly interest of $1,146.
Over the next three years Anna:
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Here's some tips and advice on what you should consider when looking at investor home loans.
An interest only home loan requires you to only repay the monthly interest on the amount borrowed (the principal) for a set term of 1-5 years.
We’re here to answer any questions you may have.
