Principal & interest vs interest-only home loans

When you take out a home loan you choose how you repay it: principal and interest or interest-only. One steadily clears your debt; the other keeps repayments low but pays nothing off. The difference costs real money, so it’s worth understanding.

Principal and interest (P&I)

Each repayment does two jobs: it covers the interest for the period, and chips away at the principal (the amount you borrowed). Over time the balance falls, so less of each repayment goes to interest and more to principal. By the end of the term, the loan is fully repaid. This is the standard choice for owner-occupiers.

Interest-only (IO)

For a set period — usually 1 to 5 years — you pay only the interest. The balance doesn’t move. Repayments are lower during this time, which helps cash flow, but you’re not building any equity through repayments.

The catch: the interest-only cliff

When the interest-only period ends, the loan reverts to principal and interest — but now you still owe the full original balance with fewer years left to repay it. So the repayments jump, often sharply. On a 30-year loan with 5 years interest-only, you then repay the whole balance over the remaining 25 years, so the P&I repayments are higher than if you’d paid P&I from the start.

And across the whole loan you pay more total interest, because the balance stayed at its maximum for longer.

When each makes sense

• Principal & interest — for owner-occupiers who want to build equity, reduce the debt, and pay the least interest overall.
• Interest-only — more common for investors, where interest may be tax-deductible and cash flow or a planned sale matters more than paying down the loan. Some owner-occupiers use a short IO period for genuine temporary cash-flow needs.

Compare the numbers

See the repayments, total interest and how fast the balance falls for a principal-and-interest loan with our mortgage repayment calculator, and how an offset balance can cut the interest either way.