Get an interest-only investment loan

This article was fact-checked and reviewed by Cam McLellan, a property investment specialist whose book, My four-year-old the property investor, has sold more than 100,000 copies. Content has been updated for 2021.

Interest-only loans end up costing borrowers more in the long run. You delay repaying the full loan amount, which makes your repayments lower in the short term when you just repay the interest. This presents investors with an opportunity because interest payments are tax deductible (payments against the loan principal are not). Investors can use interest-only loans to pay less in the short term while cutting down their tax bill.

What is an interest-only investment loan?

Australian home loans can be used to buy your own home or to buy a property as an investment. Most loans are principal and interest loans, meaning you borrow money and repay it, plus interest.

An interest-only investment loan is an investment mortgage that allows you to repay only the interest portion for a set period, usually up to five years. After that period you have to start repaying the money you actually borrowed, with interest charged on top.

With an interest-only investment loan your monthly repayments start smaller. Why? Because you're not repaying the money you've borrowed (the principal). You're just paying the interest on top.

It saves you money in the short term but can cost you more in the long term, because you may end up paying more interest over time. If used strategically, an interest-only investor mortgage can help you minimise your tax and mortgage repayments.

Learn more about how interest-only repayments work

What are the risks of interest-only loans?

It's a good idea to consider the risk or negatives when making any financial decision – then you're able to balance out the pros with the cons to make the right decision for you. Interest-only loans have a few possible drawbacks:

• With interest-only loans, you won't reduce your debt during the interest-only period. At the end of the interest-only period, you'll still owe the same amount you borrowed. For instance, if you borrow $500,000 on an interest-only loan, two years later, you'll still owe $500,000 on that loan.
• Your repayments rise significantly once your loan reverts to a principal and interest loan. This is because you now need to pay off the principal in the remaining loan term, after a period of making no headway with the overall balance. As in our previous example, if you had an interest-only loan worth $500,000 for 2 years, you would then repay the $500,000 principal (plus interest) over the remaining 28 years of the 30-year loan term. One way to get around this is to refinance the loan to a fresh 30-year term, although this means it will take you longer to own your home outright.
• Interest-only home loans can also be risky if your property fails to increase in value. This means when the interest-only period ends, you won't have as much equity in your home as you'd have if you were chipping away at the principal with a standard principal and interest loan.

None of this means interest-only loans are inherently bad or risky. You just need to be aware of the potential downsides and make sure your investment strategy suits your loan type. Getting expert help from a mortgage broker is a good idea if you're confused about interest-only investment loans.

Why would an investor choose interest-only over a principal and interest loan?

There are several reasons why investors use interest-only investment loans:

1. Tax minimisation
2. Improved cash flow through negative gearing
3. Compound growth strategy

1. Tax minimisation

Property investors can use interest-only loans to reduce their tax bill, because home loan interest is tax-deductible for investors. At the end of the financial year, you can deduct all of the interest you’ve paid on your investment property (along with a number of other tax-deductible property expenses) over the past 12 months.

Payments on the loan principal are not tax-deductible, which is why many investors favour an interest-only loan, as the extra money you would have paid towards the loan balance (in a traditional principal and interest loan) can be used elsewhere: perhaps towards another investment or to pay down your own home loan, which is not tax-deductible at all.

If you’re a property investor using an interest-only home loan, you’ll be able to deduct your entire home loan repayment from your taxes.

2. Improved cash flow

Interest-only investment home loans can be a particularly effective strategy when you factor in negative gearing, which can give you access to tax-related refunds and therefore better cash flow.

Negative gearing is a tax concession that allows you to offset any losses you make on your investment property against your personal income. For example, if your property costs you $3,000 per month to own and maintain and the rental income is $2,500, then you can claim the $500 difference on your personal tax.

This gives you what is known is better cash flow, as you can enjoy these tax refunds while you wait for the property to appreciate in value. The idea is to eventually sell the property for a capital gain, while minimising the cost of holding the property along the way; if you can keep the costs low enough, you may be able to buy more than one investment property, which allows you to compound the impact of your results. Which leads us to our next point...

3. Compound growth strategy

Some investors buy property with a high-growth strategy by choosing properties and locations they believe will grow quickly in value. Rather than holding the property for many years, renting it out and paying it off over time, these investors buy the property, minimise their repayments for a few years, then sell the property for a much greater amount than they paid.

For this strategy to work, an interest-only investment loan is essential because your repayments are much smaller at first.

A more conservative investment strategy is to buy a property, hold onto it for a long time and rent it out. Over time the value of the property will hopefully grow. With this strategy you may want to repay the loan as fast as possible using rental payments and your own money. With this strategy, a principal and interest investment loan is usually the better choice.

Need expert help? Contact a mortgage broker

How do I compare interest-only investment loans?

When comparing interest-only mortgages for investment, you need to consider these factors:

• Interest rate. A lower rate means lower repayments. It's one of the fastest ways to compare mortgages.
• Offset account. Having an offset account lets you use additional savings to reduce your interest payments even further. Read this guide to learn more about this strategy.
• Flexibility. A loan with low fees (especially discharge and switching fees) makes it easier to refinance your mortgage when the interest-only period ends. And why pay more in fees when you can avoid it?
• Structure. Structure is the most important factor when choosing your investment loan. Do not cross-secure your investment loans with the home loan on your own personal home.

Use a repayment calculator

Use the calculator below to find out what your repayment will be if you choose an interest-only home loan. Then run the same calculations for principal and interest repayments so you can see what your repayments will be once the interest-only period ends. You’ll need to pay attention to both repayment figures and determine if you’ll be able to service the new repayments once your interest-only period ends.