The Reserve Bank has upped the cash rate for the third time this year as cost of living pressures continue to bite. Could switching your mortgage to interest only be a winning idea?
As rising interest rates squeeze household budgets, many owner-occupiers are enquiring about interest-only home loans — largely associated with investors — to slash short-term repayments and boost cash flow.
The RBA's third hike this year took the cash rate to 4.35%, in line with the 2024 peak, with more hikes expected after inflation hit its highest since 2023 during April.
On a $500k 30-year loan, this new rate hike will translate to around $80 extra in monthly repayments, Mortgage Choice calculations show.
Mortgage Choice broker Chantelle Rangel says rate rises, rising living costs and the unsettling geopolitical situation are weighing heavily on buyers.
"A lot of clients have been nervous over the last three months and when interest rates rise, there's a frenzy. Some are unsure whether to shift from principal and interest loans to interest only."
The Reserve Bank of Australia has raised interest rates three times this year. Picture: Getty
Principal and interest (P&I) means you repay both the loan balance and the interest each month, so the debt shrinks over time. Interest only (IO) means you pay just the interest for a set period, so repayments are lower at first, but the loan balance doesn’t go down.
Data from the Australian Prudential Regulation Authority (APRA) shows the proportion of IO loans has risen over the last two years, from 11.1% of housing loans in December 2023 to 11.8% in December 2025.
But while there's immediate appeal of going IO in a high interest rate environment, the trade-offs are significant.
Pros
1. Lower repayments in the short term
Switching to IO slashes monthly costs. Ms Rangel says on a $500k loan, you could save $400-$500 in repayments each month compared to P&I.
2. Freed-up cash flow
The biggest draw? Extra breathing room during temporary squeezes like job loss or illness.
If going interest only brings emotional relief for a time, it may be worth it, Ms Rangel says.
"Living paycheck to paycheck is stressful, so if freeing up some cash for a while will help improve your standard of living, it's worth considering."
3. Reinvesting the savings
Going IO can help you free up cash to invest in more lucrative ways. Smart investors redirect those savings into extra properties, their owner offset accounts, or claim tax perks via negative gearing.
Interest-only loans give you other options for how to use your cash. Picture: Getty
"If you're reinvesting the money somewhere else that's going to provide you with higher returns, then that makes sense," said Ms Rangel.
4. Flexibility to pay off your principal
Once you've switched to IO, you can still make voluntary principal payments anytime. Plus, you can easily switch back to P&I with just a quick phone call, says Ms Rangel.
Going interest only, however, needs a fresh application and lender approval.
Cons
1. Higher interest rates
Interest-only loans also come with a premium, Ms Rangel warns.
"Owner-occupiers on a $500,000 P&I loan might have an interest rate of 5.7%; on interest only, this would increase to around 6%. So while you'll see a reduction in your monthly repayments, that gain is diluted a little."
2. No principal reduction
You're not chipping away at debt and are relying solely on capital to build wealth, which stings in downturns.
Ms Rangel says most owner-occupiers want to pay off their loans in less than 30 years.
"If it's your own property, it's debt that you don't want to have."
Homeowners tend to prioritise paying off their loan. Picture: Getty
3. No offset buffer
Extra P&I payments build redraw or offset safety nets for tough times, says Ms Rangel.
"Additional repayments give you a significant balance in your redraw that you can use to tie you over through high interest rate periods."
4. Reduced borrowing power
Going IO can also hurt your serviceability, in large part due to the 3% serviceability buffer added to your rate to account for changing economic circumstances.
While the buffer exists to ensure homeowners can afford repayments at a higher rate if needed, P&I loans starts from a lower base rate. Adding that same buffer to an IO loan lowers your borrowing capacity.
5. Strict limits and availability
You can't stay on IO forever; you need to repay that debt. APRA caps IO at one to five years for owner-occupiers (10-15 for investors), with total lifetime limits. Certain banks often also restrict IO loans to investors.
6. Repayment shock on reversion
When a homeowner does revert to P&I, they face a sharp jump in repayments to clear the debt over the remaining term.
"After five years IO for example, repayments recalculate over 25 years, not 30," Ms Rangel said.
7. More interest overall
That untouched principal racks up extra interest over the loan life. After five years of IO, you may pay $30k-$50k more on a $500k loan.
Interest-only loans ultimately end with having paid far more interest. Picture: Getty
Doing the sums
Ms Rangel urges buyers and homeowners to crunch the numbers first before switching from P&I to IO.
"Discuss how much repayments will increase after the interest-only period and what happens if there's no equity in the property, you haven't paid down your loan and you want to purchase another, because that may impact future decisions.
"Going interest only may free up cash flow, but it's important you understand the long-term implications" she said.
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