An interest-only loan is a mortgage where your repayments cover only the interest charged on the loan for a set period, typically one to five years. During the interest-only period, you are not paying down the principal (the amount you borrowed), so the loan balance stays the same.
Interest-only loans are popular with property investors because the lower repayments improve cash flow and the interest is fully tax-deductible on investment properties. They are central to many negative gearing strategies.
How It Works
If you borrow $500,000 at an interest rate of 6%, your interest-only repayment is approximately $2,500 per month. Compare that to a principal-and-interest repayment of roughly $3,000 per month on the same loan over 30 years. The $500 per month difference goes straight to your cash flow.
At the end of the interest-only period, the loan reverts to principal-and-interest repayments for the remaining loan term. Because the principal has not been reduced during the interest-only period, the remaining term is shorter, which means the principal-and-interest repayments will be higher than they would have been if you had been paying P&I from the start.
Why Investors Use Interest-Only Loans
The main reasons property investors choose interest-only loans include:
- Higher cash flow: lower repayments free up money for other investments or expenses
- Tax benefits: mortgage interest is tax-deductible on investment loans, and interest-only repayments are 100% deductible (principal repayments are never deductible)
- Capital allocation: investors may prefer to direct extra cash toward paying down their non-deductible owner-occupier loan first
The Trade-Off
The downside is that your loan balance does not decrease during the interest-only period. You are relying entirely on property price growth to build equity. If property values fall, you could end up with an LVR higher than when you started, or even in negative equity. You also pay more total interest over the life of the loan compared to paying principal and interest from the beginning.
Why It Matters for Landlords
Choosing between interest-only and principal-and-interest repayments is one of the most significant cash flow decisions for property investors. Interest-only repayments keep your costs lower in the short term, but they do not build equity through principal reduction. Discuss the best strategy for your situation with your mortgage broker or financial adviser.
propkt tracks your loan details and repayment structure so you can see the impact on your overall property cash flow.