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.
Is switching your mortgage to interest only a smart idea? With three interest rate hikes and the global supply chain pressures of war overseas, cost of living pressures are to biting hard in Australia.
The Reserve Bank's May rate rise took the cash rate to 4.35% — in line with the 2024 peak — with more hikes expected later this year with inflation at a near-three year high.
On a $500,000 30-year loan, each new rate hike translates to around $80 extra in monthly repayments, Mortgage Choice calculations show.
Sydney-based Mortgage Choice broker Chantelle Rangel says rate rises, rising living costs and the unsettling geopolitical situation are weighing heavily on buyers who are looking for alternatives when it comes to home financing.
"A lot of clients have been nervous over the last three months and when interest rates rise, there's a frenzy," she said. "Some are unsure whether to shift from principal and interest loans to interest only."
Interest only home loans are tempting when rates are high. Picture: Lisa Maree Williams/Getty Images
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.
Australian Prudential Regulation Authority (APRA) data shows the proportion of IO loans rising slightly from 11.1% of housing loans in December 2023 to 11.8% in December 2025, with more upticks exepcted.
But while there's immediate appeal of going IO in a high interest rate environment, the trade-offs are significant.
Here are the pros and cons of going interest only.
Pros
- 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.
- 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."
Freeing up cash can be a huge incentive when cost of living concerns are high. Picture: Getty
- 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 have historically claimed tax perks via negative gearing.
"If you're reinvesting the money somewhere else that's going to provide you with higher returns, then that makes sense," said Ms Rangel.
- 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
- Higher interest rates
Interest-only loans come with a premium, Ms Rangel says.
"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."
- 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.
Borrowers need to consider whether they are comfortable extending the overall life of their home loan. Picture: Getty
"If it's your own property, it's debt that you don't want to have."
- 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."
- Reduced borrowing power
Going IO hurts serviceability.
Lenders apply a 3% buffer rate to your interest rate when assessing serviceability to account for potential economic shifts and interest rate rises, ensuring you can afford repayments at a higher rate if needed.
P&I starts from a lower base rate of say 5.7%, plus the 3% buffer. But IO is around 6%, so adding that same buffer slashes your borrowing capacity.
- 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.
Many lenders do not even offer IO loans to non-investors, so refinancing may need to be considered first.
Owner-occupiers have a more limited range of IO options compared with investors. Picture: Getty
- Repayment shock on reversion
When you do revert to P&I, you'll see 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.
- More interest overall
That untouched principal racks up extra interest over the loan life. After five years of IO, you may pay $30,000-$50,000 more on a $500,000 loan.
Do 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.
Once they do the modelling, Ms Rangel says most of her clients decide to stay with P&I and cut back elsewhere.
"If you can ride out the next 12 months, then hopefully we'll see some rate cuts next year."
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