Interest-only repayments as a tool for property investors

As the name suggests, interest-only repayments mean you only pay interest on your loan for a set period. During this time, you don’t reduce your loan principal - the original amount borrowed - so your regular payments stay lower while your loan balance remains unchanged.

In contrast, a standard principal and interest loan includes repayments towards both the interest and the loan principal. Your regular repayments are higher, but your total loan balance reduces over time.

Here’s a quick example, for illustrative purposes only:

For a loan of $500,000 at an interest rate of 4.99% p.a.— over 30 years, your regular monthly repayments for:

• Principal and interest would be $2,682 
• Interest-only (for a 10-year period) would be $2,080

This means:

• Your monthly repayments would be $602 less during the interest-only period than if you were on principal and interest  
• Your regular repayments would increase to $3,297 per month at the end of your interest-only period as you need to repay the principal and interest over the remaining 20-year term of your loan
• With interest-only repayments, you will pay more interest over the duration of your loan
• At the end of your interest-only period your principal balance will not have changed, whereas with principal and interest repayments the principal and interest balance would’ve reduced.

There are a few common reasons why you might opt for interest-only repayments. 

Interest-only repayments are lower because you’re not repaying the loan principal (in the example above, interest-only means you would pay $602 less per month). For this reason, some investors use interest-only to create space in their budget. The extra funds might help with:

• Funding maintenance or upgrades on the property
• Paying off the loan for the home you live in faster
• Saving for a deposit for another investment property
• Supporting other financial goals or investments.

Lower repayments can also offer more breathing room when it comes to the day-to-day costs of owning a rental property, especially if it’s negatively geared (meaning the rent doesn’t cover all expenses). With more cash available, you may not need to cover as much out of your own pocket - or anything at all.

Some investors might purchase their rental property for its potential capital gains. In other words, their strategy may be to capitalise on the property’s increase in value over time, rather than from rental income in the short term. In this case, repaying the principal balance may be less of a priority for them. Keeping repayments lower with interest-only could also free up funds to invest in improvements that increase the property's value. 

Of course, another way to build value in a property is by growing equity – by paying down both the principal and interest on a loan. If that’s your strategy, interest-only repayments might not be the right fit. 

Under current rules, residential property investors can deduct 100% of the interest paid on the lending for their investment property from their rental income, reducing the amount of income tax paid. 

That said, tax settings can and do change over time. It’s a good idea to stay up to date and consider talking to a tax advisor about the rules that apply to your situation.

The deposit required for an investment property is typically higher than for the home you live in. As a result, you may have a larger mortgage on your own home than on your rental property, since you were required to contribute less upfront. 

This is why some investors use the extra cash flow from interest-only to make additional repayments on their own mortgage. Doing so could potentially reduce the interest paid on your home loan, which – unlike on your rental – isn’t tax-deductible. 

At ANZ, eligible property investors can apply for up to 10 years of interest-only repayments on residential investment property loans. For more details on this option, see Interest-only home loans for investment properties. 

As with any lending, affordability and suitability checks apply. 

An interest-only period doesn’t last forever. Once it ends, your loan will switch to principal and interest repayments - and because you’ll have fewer years remaining to repay the principal, your repayments will be greater. 

For example, if you take out a 30-year loan and make interest-only repayments for the first 10 years, you’ll need to repay the entire principal over the remaining 20 years. This means your regular repayments will be higher than if you’d been repaying both principal and interest from the start. 

It’s important to factor this into your long-term planning and make sure you’re prepared for higher repayments when the time comes. 

Interest-only could be a useful tool for managing your investment, but like any loan structure, it has pros and cons. Here are some things to think about.

Consider your returns strategy. Are you focused on short-term cash flow, aiming for capital gains, or looking to build equity by paying down the loan? Interest-only may suit the first two approaches, but not the third.

Keep in mind that interest-only repayments are calculated based on your full loan balance. Because you’re not reducing the principal during the interest-only period, you will end up paying more interest over the life of the loan.

While you’re on interest-only repayments, the equity in the property grows if the property value increases. While property values typically trend upward over the long term, there’s no guarantee your specific property will increase in value within your loan timeframe.

There’s no one-size-fits-all approach when it comes to structuring your loan – what works for others may not align with your personal goals or circumstances. While interest-only could offer greater flexibility, it’s important to weigh up the trade-offs. Your ANZ Mobile Mortgage Manager or adviser can help you understand your options and guide you through lending requirements, including affordability checks.