Interest Only Home Loan: How It Works and When It Makes Sense

By Andrew Paterson

An interest only home loan lets you pay just the interest on your mortgage for a set period, usually up to five years. Your repayments drop, but your debt stays exactly where it started.

That can be a useful tool. It can also cost you tens of thousands of dollars if there’s no clear exit plan.

This guide covers how interest only works, what it costs at November 2026 rates and what the lending rules actually say. It also covers how to decide whether it fits your situation.

How does an interest only loan work?

On a principal and interest (P&I) loan, each repayment covers the interest plus a slice of the balance. On an interest only (IO) loan, you pay the interest and nothing more.

Borrow $600,000 with a five-year IO period, and five years later you still owe $600,000.

When the IO period ends, the loan reverts to P&I. You now repay the full balance over whatever term is left.

On a 30-year loan with five years IO, that leaves 25 years. You have the same debt and less time to clear it, so repayments rise. That jump is the payment shock most borrowers underestimate.

Interest only usually costs more per dollar borrowed

Lenders price IO higher than P&I. The premium typically sits between 0.2 and 0.5 percentage points.

Mozo’s June 2026 rate tracker shows the gap clearly:

• Owner-occupier: 6.84% P&I vs 7.24% IO (a 0.40 point premium)
• Investor: 7.09% P&I vs 7.49% IO

Rates have moved since then. The RBA lifted the cash rate to 4.85% from 4 November 2026. That was its fifth hike of 2026 and took the cash rate to its highest level since 2008.

From 13 November 2026, big four variable owner-occupier rates sat at:

• Westpac and CommBank: 6.59%
• NAB: 6.69%
• ANZ: 6.75%

Interest only vs principal and interest: a worked example

Here’s how the numbers play out on a $600,000 loan over 30 years. These are illustrative figures, not a quote.

• P&I rate: 6.75%
• IO rate: 7.15% (a 0.40 point premium)
• IO period: five years, then reverting to P&I at 6.75%
• Rates held flat for the whole term to keep the comparison clean

Scenario	Monthly repayment	Balance after 5 years
P&I from day one	About $3,892	About $563,250
IO for years 1 to 5	$3,575	$600,000
P&I for years 6 to 30 (after IO)	About $4,145	n/a

What this shows:

• Short-term relief: IO saves about $317 a month for the first five years.
• The jump: When IO ends, repayments rise from $3,575 to about $4,145. That’s roughly $570 a month, or $6,840 a year.
• The long tail: For the next 25 years you pay about $254 a month more than if you’d been on P&I all along.
• Total cost: Total interest comes to about $858,000 on the IO path vs about $801,000 on straight P&I. That’s roughly $57,000 extra.

Mozo ran a similar comparison at June 2026 rates. Taking a $600,000 loan IO for five years cost around $100,580 more in total interest than P&I from the start.

The totals differ because the assumptions differ, especially how long the IO premium applies. Both calculations point the same way. IO defers repayment and adds interest.

One more variable to keep in mind. If rates rise during the IO period, the post-IO jump is bigger than the table shows.

Does interest only increase your borrowing power?

Not in any meaningful way in 2026. This is the point most bank product pages leave out.

Lenders don’t assess you on the lower IO repayment. They assess the P&I repayment over the residual term, then apply APRA’s 3 percentage point serviceability buffer on top.

Using the example above, the lender tests repayments at 9.75% (6.75% plus 3%):

• Standard 30-year P&I loan: assessed at about $5,155 a month
• 30-year loan with five years IO, assessed over the 25-year residual term: about $5,347 a month

The IO loan looks about $190 a month harder to service. So IO can ease your cash flow. It generally won’t help you borrow more.

The rules: what changed and when

Plenty of articles blur these dates together. Here’s the actual sequence:

1. 2015: ASIC Report 445 set out the “residual term method”. Under it, lenders assess IO loans on the P&I repayment that applies after the IO period ends.
2. March 2017: APRA introduced a benchmark limiting new IO lending to 30% of new mortgage originations.
3. 1 January 2019: APRA removed the 30% benchmark. There is no system-wide IO lending cap today.
4. 2019: In the Westpac responsible-lending case, the Federal Court found the residual term method was not a legally mandatory step for variable-rate loans. It remains ASIC’s stated guidance and standard industry practice.
5. October 2021: APRA lifted the serviceability buffer from 2.5 to 3 percentage points. It remains at 3 points through 2026.
6. 1 February 2026: APRA’s debt-to-income (DTI) limit took effect. Loans at six times income or more are capped at 20% of new lending, applied separately to owner-occupier and investor books.

IO term limits are lender policy, not regulation

APRA sets no numeric cap on how long an IO period can run. Each lender sets its own limit.

• Most lenders cap owner-occupier IO at five years over the life of the loan.
• Investor IO caps commonly sit between five and 10 years per term.
• Westpac publishes up to 15 years IO on investment loans, subject to approval.

How the DTI cap interacts with interest only

IO doesn’t reduce your debt, so your debt-to-income ratio doesn’t improve while you’re on it.

Investors already run higher ratios. Around 10% of new investor loans are written at a DTI of six or more, compared with about 4% of new owner-occupier loans.

Borrowers holding several IO investment loans are the most likely to meet tighter lender appetite under the new cap. Non-bank lenders aren’t subject to APRA’s DTI cap or its direct supervision. Even so, the buffer and higher rates still constrain how much anyone can borrow.

When interest only can help

ASIC’s view is that IO loans can be appropriate in the right circumstances. The risk arises when you can only afford the loan because it’s IO. It also arises when you can’t afford the P&I repayment that follows.

These are the situations where IO tends to earn a place in the conversation.

Clearing higher-interest, non-deductible debt

Some borrowers use IO to free up cash and clear credit cards or personal loans faster. They then switch back to P&I once that debt is gone.

This works best with a fixed end date and enough freed cash to make a real dent. The worked example in the next section shows why the numbers need checking.

A known, temporary cash-flow dip

Parental leave, a career change, study or a period of lumpy self-employed income can all squeeze cash flow for a defined stretch. IO can soften that period.

The key word is temporary. The plan should name when income returns and when P&I resumes.

Investors using interest only with an offset

Some investors keep their investment loan on IO. They direct spare cash to their home loan or into an offset account linked to the investment loan.

Money in an offset reduces the interest charged and stays accessible. Whether this structure suits you depends on several things:

• your tax position
• your other debts
• whether you plan to hold or sell
• how stable your income is

An offset can also suit someone who is still building savings or expects irregular income. It doesn’t require a big balance on day one, because circumstances change over the life of a loan.

How interest deductions apply to you is a question for your accountant or tax agent.

When the maths doesn’t stack up: a debt-clearing example

Take the same $600,000 loan. Switching to IO frees up about $317 a month.

Say you put that toward a $12,000 credit card at 20% interest. You were already paying $400 a month on it.

• At $400 a month: the card clears in about 42 months, with roughly $4,760 in interest.
• At $717 a month: it clears in about 20 months, with roughly $2,200 in interest.
• Card interest saved: about $2,560.

Now the cost side. The 0.40 point IO premium on $600,000 adds about $200 a month, or roughly $4,000 over those 20 months.

Your mortgage also hasn’t moved. On P&I, the balance would have fallen by about $10,900 in that time.

In this case, IO costs more than it saves. The numbers can flip in other cases, for example:

• the debt is larger or carries a higher rate
• the lender charges a smaller IO premium
• the freed cash is a bigger share of the repayment

It’s also worth comparing alternatives:

• a balance transfer card with a hard payoff plan
• consolidating into the mortgage while keeping repayments high, so the debt isn’t stretched over decades
• a budget reset on your existing P&I loan

This is why we model both paths before recommending anything.

Switching from interest only to principal and interest

When the IO period ends, most loans revert to P&I automatically. Your lender should notify you before that happens.

You generally have a few options:

1. Let it revert. Budget for the higher repayment well in advance.
2. Soften the jump early. Make voluntary principal repayments during the IO period, if your loan allows it.
3. Switch early. Move to P&I before the IO term ends, once the reason for IO has passed.
4. Request an extension. This usually needs a fresh assessment under current rules, so approval isn’t guaranteed.
5. Refinance. A new lender will assess you on today’s buffer and DTI settings, not the ones that applied when you first borrowed.

Start planning six to 12 months before expiry. If your income or expenses have changed, you want to know before the lender’s letter arrives.

A checklist before you choose interest only

Work through these questions honestly:

1. What specific job is IO doing for you? Write it down in one sentence.
2. When does it end, and what triggers the switch back to P&I?
3. Could you afford the post-IO P&I repayment today, with room to spare?
4. What does the IO premium cost per year compared with the benefit you expect?
5. Could an offset, redraw or a restructure of your P&I loan do the same job for less?
6. If you’re an investor, has your accountant reviewed the structure?
7. How would another rate rise affect both the IO repayment and the jump afterwards?

A shaky answer doesn’t automatically rule IO out. It’s a signal to look harder at the numbers and the alternatives.

Your situation will also change over time. A structure that suits you today may need a review in two or three years.

How a broker can help

At Aussiewide, we start with what you’re trying to achieve, not with the product. Then we model the IO and P&I paths side by side at current rates.

We compare IO premiums and term caps across lenders, including non-banks where relevant. We also check that the post-IO repayment fits your budget before you commit.

If IO isn’t the right tool, we’ll say so and show you what else could do the job.

Important information

• This article is general information only and does not constitute personal financial or credit advice. It does not take into account your objectives, financial situation or needs. Seek advice from a licensed mortgage broker or financial adviser before acting.
• Interest rates, APRA policy settings (including the 3% serviceability buffer and the February 2026 DTI cap) and lender IO term limits can change. Figures are current as at November 2026. Verify them with the relevant lender, APRA or ASIC before relying on them.
• Whether an interest only loan is appropriate depends on your circumstances. These include whether you’re an owner-occupier or investor, your tax position and your ability to service the post-IO P&I repayment. A credit provider or broker must conduct its own responsible lending assessment, and this article is not a substitute for that.
• The tax treatment of investment loan interest depends on your circumstances. It is a matter for a qualified tax agent or accountant.
• Worked examples are illustrative only. They assume constant rates and do not include fees.

Frequently asked questions

How long can you have an interest only home loan?

It depends on the lender, not a regulatory rule. Most lenders cap owner-occupier IO at five years over the life of the loan. Investor caps commonly run five to 10 years per term, and Westpac publishes up to 15 years on investment loans, subject to approval.

What happens when my interest only period ends?

The loan usually reverts to principal and interest over the remaining term, so repayments rise. On a $600,000 loan in our example, they jumped from $3,575 to about $4,145 a month. You can also ask about an extension or refinance, but both involve a fresh assessment.

Can I make extra repayments on an interest only loan?

Many variable IO loans allow extra repayments, and they reduce your balance and future interest. Fixed-rate IO loans often limit extra repayments, so check your loan terms first.

Is interest only better for an investment property?

It can suit some investors, especially alongside an offset account, but it depends on your tax position, other debts, income stability and plans for the property. Your accountant should review the tax side before you decide.

Will an interest only loan help me borrow more?

Generally no. Lenders assess the principal and interest repayment over the shorter residual term, plus APRA’s 3 percentage point buffer. That can make an IO loan look harder to service than a standard 30-year P&I loan.