An interest-only mortgage is a repayment structure where your monthly repayments cover only the interest on the borrowed amount.
While it may sound appealing due to the lower monthly payments, failing to manage this repayment system wisely could potentially put you at a great financial risk down the years.
That is, over time, if you do not plan accordingly, you may find yourself facing a large remaining balance that could be way above what you can afford.
This is why this comprehensive guide is essential. We’ll get deeper into how an interest-only mortgage works, the benefits, risks, and more.
Ready to learn more? Let’s get started.
When it comes to mortgage payments, you have two components to consider:
Principal: the total amount of money you borrow from the lender. This is the original sum that you are obligated to repay over the life of the loan.
Interest: the money your lender charges you on the principal amount. This is expressed as a percentage and calculated based on the outstanding loan balance.
In an interest-only mortgage, you only repay the interest amount every month for a set period of time.
That means your principal amount remains as is. So, even if you’ve repaid the minimum amount for the entire duration of your interest-only mortgage, you’ll still have the principal to pay back in its entirety.
Here’s an easy example to put this into perspective...
Imagine you get a mortgage of $600,000 with an interest rate of 6% per year. Due to temporary financial constraints, you opted for an interest-only mortgage for the first 5 years:
Principal Amount: $600,000
Interest Rate: 6% annually
Interested-Only Period: 5 years
Since you’ve opted to only pay the interest on your mortgage, your minimum monthly repayment amount comes to $3,000.
That means in 5 years, you would’ve paid $180,000 in interest alone. But even after these many years and this much interest, you’d still owe the principal mortgage amount of $600,000 to the lender!
Interest-only mortgage payment allows you to pay just the interest on your loan for a specified term, often 5 to 10 years. This means lower monthly repayments during the interest-only period.
However, the principal amount remains unchanged, meaning that at the end of the interest-only term, you will still owe the full original loan amount.
But when it comes to a standard repayment structure, your minimum repayments are calculated on an interest + principal basis. Here, the minimum monthly repayment amount would cover the interest as well as a fraction of the principal amount, so with each repayment, your overall loan balance gradually comes down.
A great advantage of the standard repayment structure is amortisation—the gradual reduction of the loan balance over time. With each payment, you will see a portion allocated towards interest, while the remaining amount reduces the principal.
This ultimately helps you lower your debt and also build equity in your property over the life of the loan.
It’s worth noting that in both cases, lenders and mortgage brokers are required to adhere to the responsible lending guidelines set by the Australian National Consumer Credit Protection Act 2009 (NCCP Act):
Suitability: Lenders and mortgage brokers must act in the best interest of the consumer by carefully evaluating their requirements and objectives.
Financial Capacity: Lenders and mortgage brokers must make reasonable enquiries into the consumer’s financial standing rather than relying solely on benchmark figures.
With these regulations, there is assurance to some extent that the offers you get from lenders are not only suitable but also sustainable for you.
But to ensure you are making the right decision, it’s always a good practice to consult a financial advisor or legal professional to navigate the complex structure of finances and mortgages.
Homebuyers usually prefer an interest-only mortgage for these three benefits:
Lower monthly payments during the interest-only period.
Increased cash flow flexibility.
Potential uses like investing in other ventures or saving for other expenses.
Are you looking to utilise any of these benefits with an interest-only mortgage?
Get in touch with us—Koalify is one of the best mortgage brokers in Australia with 30+ top lending partners. We compare and personalise different mortgage options for you from the right lenders. It's free. No service fee!
Contact us today to discuss your options for free.
While there are some benefits, it’s safe to say that interest-only mortgage payments have more risks than benefits. And the stake is too high if you don’t plan and use this repayment structure wisely.
So, here are all the risks and considerations you should keep in mind when going for an interest-only mortgage.
An interest-only mortgage usually charges a higher interest rate during its tenure.
Higher overall cost of the loan over its lifetime.
An interest-only mortgage ends after a certain period of time, like 5 years.
You can’t build any equity in the home during the interest-only period.
Your minimum monthly repayment amount can significantly increase after the interest-only period to cover a part of the principal amount going forward.
The higher repayments after the interest-only period may strain your budget and could potentially lead to financial distress and mortgage stress.
The Australian Securities and Investments Commission (ASIC) in 2015 found that lenders often failed to consider whether such loans met borrowers’ needs, especially in the medium to long term. Issues involved primarily the inadequate verification of their financial capacity that did not account for the eventual increase in repayments when the interest-only period ended.
So, make sure to plan for the increased repayment structure if you’re in an interest-only mortgage or planning to get one. Two great ways to plan ahead are:
Use an offset account.
Pay extra towards the principal amount during the interest-only period if your lender allows.
You may contact your lender to get an accurate representation of the payment structure or use the Australian government’s before and after interest-only mortgage calculator.
If you fall into any of these three categories, you may consider getting or switching to an interest-only mortgage.
In any case, you must carefully consider the long-term financial implications of an interest-only mortgage. Although the short-term benefits can be tempting, you need to be aware of the potential risks, such as payment shock or negative equity.
We strongly advise you to always weigh your options and consult with a financial advisor to ensure the right choice for your situation.
With a lower repayment structure, interest-only mortgages can help investors looking to spare some extra cash for the short term.
This setup allows them to free up cash flow for other investments or expenditures.
For those who experience variability in their earnings (freelancers, commission-based workers, seasonal employees, etc.), the reduced payments during the interest-only period provide greater financial flexibility.
This can help ease the burden during lean months, allowing them to stabilise their finances without the pressure of high monthly mortgage payments.
If you anticipate moving within a few years, the ability to make lower payments allows you to allocate funds towards renovations or other investments that could enhance your home's market value.
This could potentially position you for a profitable sale before the full mortgage payments kick in.
So, what if you’re currently in a standard repayment structure and you want to change to an interest-only mortgage for some reason? You can do that in two ways.
One, just ask your current lender for an interest-only period. They’ll look at your history with them, your current financial standing, and your affordability regarding the increased payments after the interest-only period.
If everything is satisfactory, they’ll proceed with your interest-only application. You’ll want to choose between a fixed or variable interest rate setup as well.
The second option is to refinance. If your lender refuses to switch to an interest-only mortgage, you can refinance to one with another lender. It’s always a good idea to use a refinance broker if you want to get unbiased advice and favourable offers.
Keep in mind that in both these cases, lenders will verify your financial standing thoroughly according to the responsible lending guidelines set by the Australian National Consumer Credit Protection Act 2009 (NCCP Act).
If you’re already engaged in an interest-only mortgage, you must have an exit strategy in place to smoothly transition to the standard repayment structure. Refer to the Australian government’s official article that clearly outlines how you can manage the switch from interest-only to principal + interest payments.
However, if you want to exit the interest-only mortgage early, you can do it in 4 ways:
Ask your lender: Let your lender know you’d like to switch to a standard repayment structure. If you’re in a fixed-rate interest-only period, there might be some break fee involved.
Refinance: Refinance the interest-only mortgage with the same or another lender. Some associated costs are exit fees, discharge fees, new loan setup costs, etc.
Close the loan early: If you have the funds available, you can pay off the mortgage early to exit from the interest-only mortgage as well as the mortgage as a whole. Consult with your lender to see if there is any repayment penalty.
Sell the property: Another way to settle the loan entirely, regardless of the remaining interest-only period, is by selling your home.
Again, exiting from an interest-only period will usually attract some kinds of fees depending on your lender. It’s worth consulting your lender or financial advisor to be accurately informed of any fees or charges.
At the end of the interest-only term, you will need to start making principal payments in addition to the interest, which may significantly increase your monthly payments.
Yes, you can refinance an interest-only mortgage, but you’ll most likely have to do it with another lender.
You can either refinance into another interest-only mortgage or a traditional one that involves both principal and interest payments, but with better terms than your current lender if your profile is satisfactory.
Interest-only mortgages can help people with fluctuating incomes, investors, and people looking to sell their property before the ends of the interest-only period.
While this financing option does come with some appealing benefits, it is not for everyone due to the many risks involved.
Before you make a decision, kindly consult with a financial advisor to weigh the pros and cons specific to your situation. Factors such as market conditions, personal financial goals, and risk tolerance play vital roles in determining whether this type of mortgage is a fitting choice for you.
This information here is general in nature and not intended to be financial or legal advice. Always consult a professional to tailor the best solution for your circumstances.
Let our home loan experts secure the most suitable deal for you
The images or content displayed on the koalify.au website, which feature financial product details including interest rates, are solely for demonstration purposes.The Koalify website does not endorse any specific credit products, and nothing contained within the site should be interpreted as offering credit advice. Should you opt to engage with a Koalify home loan expert, credit assistance might then be provided, at which point you will receive the pertinent information and documentation relevant to your interaction. Access and use of this site and any of its services are governed by our Terms & Conditions and Privacy Policy.
© 2025 Koalify. KOALIFY GROUP PTY LTD trading as Koalify. ABN 43673755130. Credit Representative Number 557851 is authorised under Australian Credit Licence Number 389328. All Rights Reserved.