Principal & interest vs interest only

P&I pays down the loan; IO doesn't and costs more long-term. APRA's debt-to-income cap now also shapes how much IO investor lending a bank can write.

5 min read·Reviewed 11 July 2026·Ratesniffers Editorial Team

P&I vs interest-only: at a glance

The core difference: principal & interest pays the loan down, interest-only doesn't.

Feature	Principal & interest	Interest only
Each repayment	Interest + part of the principal	Interest only
Loan balance	Falls over time, reaches $0	Unchanged during the IO term
Monthly repayment	Higher	25–35% lower during the IO term
When the IO term ends	—	Reverts to P&I, repayments jump
Rate	Usually lower	Typically 0.10–0.30% higher
Builds equity via repayments?	Yes	No, only via capital growth
Best for	Owner-occupiers paying down the home	Investors maximising deductible interest and cash flow

How does each repayment type work?

P&I (Principal & Interest): every monthly payment covers the interest charge plus a portion of the principal. The loan balance reduces over time. By month 360 (year 30), the balance is zero.

Interest Only (IO): payments cover only the interest charge, the principal balance stays the same throughout the IO period (usually 1-5 years). After IO ends, the loan converts to P&I and repayments jump significantly because the same principal must now be paid down over the remaining shorter term.

Why do investors use interest-only loans?

Cash flow, IO repayments are typically 25-35% lower than P&I, which can be the difference between a property being cash-flow neutral or a $400/month cash drain.

What are the risks of an interest-only loan?

APRA's dedicated 30% interest-only lending benchmark, introduced in 2017, was removed in December 2018 once new IO lending had fallen well under that level. It has since been replaced by a different macroprudential lever: from 1 February 2026, APRA limits ADIs to writing no more than 20% of new mortgage lending to borrowers with a debt-to-income ratio of 6 times income or more, measured separately for owner-occupier and investor lending each quarter. Because an IO loan doesn't reduce the principal during the interest-only period, a borrower's debt-to-income ratio stays higher for longer than it would under P&I, which is one more reason a lender may weigh an IO application more closely under this cap.

Principal & interest vs interest only: frequently asked questions

How does each repayment type work?

P&I (Principal & Interest): every monthly payment covers the interest charge plus a portion of the principal. The loan balance reduces over time. By month 360 (year 30), the balance is zero. Interest Only (IO): payments cover only the interest charge, the principal balance stays the same throughout the IO period (usually 1-5 years). After IO ends, the loan converts to P&I and repayments jump significantly because the same principal must now be paid down over the remaining shorter term.

Why do investors use interest-only loans?

Tax, interest is deductible, principal repayments aren't. By paying only interest on the investment loan, the investor maximises deductible expenses while keeping spare cash to pay down their owner-occupied loan (where principal repayments don't yield tax benefits). Cash flow, IO repayments are typically 25-35% lower than P&I, which can be the difference between a property being cash-flow neutral or a $400/month cash drain.

What are the risks of an interest-only loan?

End-of-IO payment shock: when IO converts to P&I, repayments jump dramatically. Many borrowers have to refinance to extend or restructure. Higher rate: most lenders price IO at 0.10-0.30% above the equivalent P&I rate. Equity standstill: you don't build equity through repayments, only through capital growth. In a flat market, that's nothing for years. APRA's dedicated 30% interest-only lending benchmark, introduced in 2017, was removed in December 2018 once new IO lending had fallen well under that level. It has since been replaced by a different macroprudential lever: from 1 February 2026,…

References

APRA: Activating debt-to-income limits as a macroprudential policy tool, Current DTI lending cap, effective 1 February 2026
APRA: Removal of the interest-only lending benchmark, History of the 2017-2018 IO benchmark
ASIC MoneySmart: Choosing a home loan, P&I vs IO consumer guidance
ATO: Rental expenses you can claim now, Interest deductibility for IO investor loans

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