When you take out a loan for an investment property in Australia, one of the first choices you face is how to repay it.
The two main options are interest only and principal and interest. They sound technical, but the idea behind each is simple.
Understanding how an interest only loan compares to principal and interest helps you ask the right questions before you commit.
What is a principal and interest loan?
Principal and interest, or P&I, means every repayment covers two things: the interest charged on the loan, and a portion of the actual amount you borrowed.
Bit by bit, the loan balance shrinks. After 30 years, the loan is paid off entirely.
Because each repayment is doing double duty (covering both the interest and reducing the debt) P&I repayments are typically higher than interest-only repayments.
What is an interest only loan in Australia?
An interest only loan means that for a set period of time, typically one to five years for investment loans in Australia, you pay only the interest charged each month. The amount you borrowed stays exactly where it is during that time.
Your monthly repayments are lower because you are only paying the interest, not reducing the debt. But when the interest only period ends, the loan reverts to principal and interest, and your repayments go up, often significantly, because you are now repaying the full original balance over a shorter remaining term.
What is the difference and why does it matter?
The key difference is cash flow today versus the total cost over time.
An interest only loan can ease cash flow in the short term because the repayments are lower. Some investors use this to free up cash during the early years of holding a property, particularly while they are building an investment portfolio or managing other financial commitments.
A principal and interest loan costs more each month but steadily reduces the debt. Over the life of the loan, the total interest paid is typically lower than on an interest only loan because the balance is shrinking from day one.
Neither option is universally better. They suit different circumstances, different financial positions, and different goals.
What happens when the interest only period ends?
This is the part many borrowers do not think about carefully enough before signing. When an interest only period ends, the loan automatically switches to principal and interest. Because the loan balance has not reduced during the interest only period, the remaining term is now shorter, and the repayments jump significantly.
For example: a $500,000 loan on a 30-year term with a five-year interest only period becomes a $500,000 loan with 25 years to repay it once the interest only period ends. The repayments increase, sometimes by a meaningful amount.
Understanding this before you choose a loan structure is important. It is not a reason to avoid interest only loans, but it is a reason to plan for what comes next, not just what suits you today.
How loan structure fits into a long-term investment strategy
Loan structure is one of the most important decisions an investment property owner makes and it is one that a good mortgage broker can help you work through based on your specific income, borrowing capacity and goals.
At Austral Financial, we introduce clients to trusted, independent mortgage brokers who can walk through both options in detail. Our role is to help you understand how these choices work so you can have a more informed conversation with the right professional.
If you would like to understand how loan structure fits into a long-term property investment strategy for your family, send us a message.
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