Interest-Only vs Principal and Interest: What Your Broker Isn't Telling You

Most property investors treat the interest-only versus principal and interest decision as a simple repayment preference. Pick the lower repayment, or pick the one that pays the loan down faster. Done.

That framing misses almost everything that actually matters. The choice affects how much a bank thinks an investor can borrow, whether they can qualify for the next property at all, and how quickly a portfolio can scale beyond two or three assets.

A conversation between Arjun Paliwal, CEO & Head of Research at InvestorKit and Jack Fouracre, Head of Broker Division at Fouracre Financial, unpacks why this decision sits at the centre of property strategy rather than at the margins of it. The numbers involved are larger than most investors realise, and the right structure can be the difference between stalling at two properties and reaching four or five.

What Happened

The discussion breaks down the mechanics of interest-only and principal and interest loans, then moves into how each is treated differently depending on the lender. A central theme is that major banks assess interest-only loans conservatively, calculating serviceability as though the loan will revert to principal and interest on a shortened term. This quietly reduces borrowing capacity, sometimes by well over $100,000, even though the actual repayment during the interest-only period is lower.

The conversation also explores how loan-to-value ratio changes the calculus, why some lenders assess interest-only repayments at face value rather than a future P&I figure, and how a hybrid structure, using principal and interest on one property while keeping the rest interest-only, can unlock both better servicing and a faster path to refinancing. A separate but related idea addresses how inflation erodes the real burden of a fixed loan balance over decades, reframing why long-term interest-only holding can make sense for some investors.

Throughout, the emphasis stays on structure and sequencing rather than any single "correct" loan type. The right approach depends on an investor's cash flow position, their LVR, and how many properties they intend to acquire.

Key Takeaways

The Basic Mechanics: What Each Loan Type Actually Does

A principal and interest loan reduces both the interest owed and the loan balance over time, with the interest portion shrinking as the balance falls. An interest-only loan, typically structured for one to five years, means repayments cover interest alone, and the balance stays fixed until the interest-only period ends and the loan reverts to principal and interest, usually at a higher repayment because the same balance is now paid down over a shorter remaining term.

Why a Cheaper Rate Doesn't Mean a Cheaper Loan

Principal and interest loans generally carry a lower interest rate than interest-only loans, often by 0.25% to 0.5%. On a $700,000 loan, that gap might save around $2,100 a year in interest. But the repayment difference tells a different story: the same loan can cost several hundred dollars more per month under principal and interest, adding up to roughly $6,000 to $7,000 a year in extra repayments. Across a three-property portfolio, that's in the order of $20,000 annually, a figure that dwarfs the interest saving on the cheaper rate.

Why Major Banks Penalise Interest-Only Borrowing Power

Many major lenders don't assess an interest-only loan based on its current repayment. Instead, they calculate what the repayment will be once it reverts to principal and interest on the remaining loan term, whether that's 25, 27 or 29 years. On a $700,000 loan at 6%, the gap between a 30-year assessment and a 25-year assessment can amount to a servicing shortfall of over $300 per month, which can translate to $100,000 or more in reduced borrowing capacity.

The Trade-Off: Extra Borrowing Power vs Extra Properties

Some lenders assess interest-only loans based on the actual repayment being made, not a hypothetical future one. For an investor holding several interest-only properties, this can preserve tens of thousands of dollars in annual serviceable income, capacity that a major bank would otherwise treat as committed to higher future repayments. For many investors, choosing the right lender for this stage of their portfolio can be the difference of one or two additional properties.

How Loan-to-Value Ratio Changes the Right Approach

At lower LVRs, such as 80%, investors typically have more flexibility to choose interest-only structures. As LVR rises toward 90% or 97%, some lenders restrict or remove interest-only options altogether, and servicing can tighten regardless of loan type. In these higher-LVR scenarios, some investors deliberately choose principal and interest, not for servicing reasons, but to build equity faster when cash flow isn't the primary constraint.

The Purchase Split Strategy: Mixing Loan Types Within a Portfolio

Rather than treating a portfolio as uniformly interest-only or uniformly principal and interest, some investors structure a new purchase on principal and interest while keeping existing loans interest-only. This can improve access to lenders that don't offer interest-only at higher LVRs, accelerate the path from 90% to 80% LVR (opening the door to refinancing and a potential partial refund of lenders mortgage insurance within the first two years), and preserve serviceability across the rest of the portfolio.

Why Fixing a Rate Can Support a Longer-Term Exit Strategy

At high LVRs, variable rates from some lenders can sit meaningfully higher than their fixed alternatives, partly because lenders prefer borrowers not to refinance shortly after settlement. Fixing a rate for one or two years can secure a materially lower rate while an investor works toward a valuation uplift and LVR reduction, provided the fix aligns with a clear, time-bound exit plan rather than being left to expire without review.

The Inflation Effect on Long-Held Debt

A fixed loan balance becomes progressively less burdensome over time as wages, asset values and general prices rise, even though the number on the loan statement never changes. A $50,000 loan balance that felt significant decades ago can feel negligible against a property now worth well over a million dollars. This is part of the reasoning some investors use for holding interest-only debt long-term rather than prioritising principal reduction, particularly on loans that predate policy changes and carry grandfathered terms.

Loan Structure Comparison ($700,000 loan, 6% P&I / 6.3% interest-only)

• Interest saved per year on P&I vs interest-only: approximately $2,100

• Extra annual repayment cost of P&I vs interest-only: approximately $6,000–$7,000

• Annual repayment saving across three interest-only properties: approximately $20,000

• Servicing gap between 30-year and 25-year assessment terms: approximately $313/month (~$3,756/year)

• Estimated borrowing capacity impact: $100,000–$150,000

• Potential additional properties unlocked through correct structuring: 1–2

  
  

Actionable Lessons for Investors

• Understand that a lower advertised rate on principal and interest doesn't automatically mean a lower-cost loan once repayment differences are factored in.

• Check how a prospective lender assesses interest-only loans for serviceability, since this varies significantly and can materially affect borrowing capacity.

• Consider LVR thresholds carefully, as options and pricing can shift meaningfully at 80%, 90% and 97%.

• Explore whether a split structure, principal and interest on a new purchase while retaining interest-only on existing loans, could support both serviceability and a faster refinancing timeline.

• Review interest-only terms before they expire rather than letting them roll over by default, particularly with major lenders.

• Work with a broker who structures lending around a multi-property strategy rather than assessing each loan in isolation.

The interest-only versus principal and interest decision isn't really a question with one correct answer. It's a structural choice that shifts depending on an investor's LVR, cash flow position, and how many properties they're aiming to hold. Investors who treat it as a simple repayment preference risk leaving borrowing capacity, and future purchases, on the table. Getting the structure right, informed by a clear view of servicing rules and long-term strategy, is what allows a portfolio to keep growing rather than stall out at two or three properties.

If you'd like to work with a broker who understands your situation and gives you clarity, book a free discovery call with the Fouracre Financial team.

If you want to see how this can apply to your own portfolio, book a free discovery call with the InvestorKit team.

Disclaimer

This article is general information only and does not constitute financial, legal or tax advice. Investors should seek advice relevant to their circumstances.