Buying a home is a big financial commitment — and choosing the right loan structure can make a big difference to your cash flow and long-term financial goals. One option that some borrowers consider is an interest-only loan. While it’s not suitable for everyone, under the right circumstances, an interest-only loan can offer flexibility and short-term relief.
What is an interest-only loan?
An interest-only loan is a type of mortgage where, for a set period (usually between 1 to 5 years), you only pay the interest on the loan — not the principal. This means your repayments are lower during the interest-only period, but your loan balance doesn’t reduce. Once the interest-only period ends, your repayments will increase as you begin paying off both the principal and interest.
How does it help borrowers?
Interest-only loans can be useful in situations where cash flow is tight, or where borrowers want to maximise flexibility in the short term. Here are some common scenarios where it might make sense:
- Investors: Property investors may use interest-only loans to reduce repayments while the property grows in value. The goal is often to sell or refinance later, using capital growth to their advantage.
- Short-term income changes: If you’re expecting a temporary dip in income (e.g. starting a new business, parental leave), interest-only repayments can ease financial pressure on the house-hold budget.
- Renovation or construction: During a build or renovation, interest-only loans can help manage costs until the property is complete and generating income or ready for sale.
- First-home buyers: In some cases, first-home buyers may use interest-only loans to ease into home ownership, especially if they expect their income to increase in the near future.
What are the risks?
While interest-only loans offer short-term relief, they come with important considerations:
- No equity growth from repayments: Since you’re not paying down the loan balance, you’re not building equity unless the property value increases.
- Higher repayments later: Once the interest-only period ends, repayments can jump significantly. It’s important to plan for this.
- Potential for negative equity: If property values fall and you haven’t reduced your loan balance, you could owe more than the property is worth.
- Stricter lending criteria: Lenders often assess interest-only loans more conservatively, especially for owner-occupiers.
How it works in practice
Alex and Jordan own their own principal place of residence, currently valued at $1 million, with $600,000 remaining on their home loan. They’ve used available equity to assist with purchasing a 2-bedroom unit as an investment property for $400,000. To fund the investment, they take out a separate loan for the full purchase price, structured as interest-only for 5-years. Because the investment loan is tax-deductible, they benefit from a tax offset on the interest repayments, reducing the effective cost of the loan. This strategy allows them to keep repayments low on the investment loan and maximise additional contributions into their home loan, which is not tax-deductible. By prioritising repayment of their principal place of residence loan, they aim to reduce non-deductible debt faster while building long-term wealth through property investment.
Final thoughts
Interest-only loans aren’t for everyone — but they can be a strategic tool when used wisely. Whether you're an investor, a first-home buyer, or navigating a temporary financial shift, understanding how interest-only loans work can help you make informed decisions.
If you're considering this option, speak with a broker or lender to assess whether it suits your financial goals and risk profile