Interest-only vs principal-and-interest

On a standard principal-and-interest (P&I) loan, every repayment does two jobs: it pays the month's interest, and it chips away at the principal — the amount you borrowed. On an interest-only (IO) loan, repayments do only the first job. As Moneysmart puts it: for a set period, "you pay nothing off the amount borrowed."

That's the whole mechanism, and it explains both the appeal and the cost. The appeal: interest alone is the smaller bill, so IO repayments are noticeably lighter for the whole period. The cost: at the end of that period you owe exactly what you borrowed on day one. Years of payments, and the debt hasn't moved a dollar.

It helps to name the thing honestly: during an IO period you're renting the money — full use of the loan, nothing accumulating toward ownership of it. Sometimes renting is precisely the right structure. But the housing analogy carries: nobody confuses years of rent with years of mortgage progress, and IO deserves the same clarity.

IO periods end, and Moneysmart describes what happens next without decoration: the loan converts to principal-and-interest, "you'll start repaying the amount borrowed, as well as interest on that amount. That means higher repayments."

The step-up is worse than most borrowers intuit, because it's a double squeeze. First, repayments now include principal at all — the job they'd been skipping. Second, the untouched principal must amortise over the remaining term only: borrow over a long term, spend the first years interest-only, and the entire original debt must now fit into the years left. Same debt, fewer years, bigger number — the widget below computes it exactly.

Moneysmart's advice for surviving the date is the same discipline our fixed-rate expiry section preaches: make sure you can afford the higher repayments before choosing the structure, and give yourself breathing room — if rates rise between now and the step-up, the after-IO number rises with them (how rates travel is the cash-rate page's story). Diarise the end date; the do-nothing option is a repayment shock with a calendar entry.

Interest is charged on what you owe — and on an IO loan, what you owe stays at its maximum for the whole IO period. Every month a P&I borrower shrinks their balance, next month's interest shrinks with it; the IO borrower pays interest on the full amount, every month, for years. The gap compounds quietly and shows up as a distinctly larger lifetime interest bill.

There's often a second layer: Moneysmart notes the interest rate itself can be higher on interest-only loans — "so you pay more over the life of the loan" twice over: more months at full balance, at a possibly higher price. When comparing quotes, compare the IO rate against the P&I rate you'd otherwise get, not against the IO fantasy of the same rate.

None of this is hidden — it's the visible price of the lighter years. The widget below puts all three numbers side by side for your own loan: the IO-period repayment, the after-IO repayment, and the lifetime interest gap against just paying P&I from day one. Look at the third number before falling in love with the first.

Moneysmart identifies the two honest users. Investors, first: on an investment property the interest is generally the tax-relevant cost, and some investors prefer to keep the loan's principal intact while directing spare cash elsewhere — a structure decision with real tax implications that belongs with a licensed adviser, not a lunch-room tip.

Second, borrowers with a genuine short-term cash-flow reason and an exit plan: a temporary income dip, a renovation year, a bridge between properties. The key word is temporary — a defined season the lighter repayments are buying you through, with the step-up date and the after-IO number known in advance.

Who it doesn't suit is anyone using it to "afford" a bigger loan — if the P&I repayment doesn't fit your budget, the loan doesn't fit your budget; IO just postpones the introduction. And if lighter repayments have become a survival tool on a loan you already hold, that's a hardship conversation, not a structure choice — your lender's hardship team and the free help on our debt page exist for exactly that.