After the bank said no, a new plan across two states.
What is a principal and interest loan?
A principal and interest loan has regular payments that cover interest and pay back some of the debt. Principal means the amount you borrowed. If you make the agreed payments, you clear the loan over its term. This differs from an interest-only phase, when the payments due leave the debt unchanged.
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How is each repayment split?
One part pays interest on what you still owe. The rest pays back some of the debt. At first, the interest share is usually larger. As the debt falls, more can go to paying it off, if the rate and payment stay the same.
Fees and rate changes can affect both the balance and what you have to pay. Your loan statement shows the charges made. It also shows the debt left to pay, so you can see the two parts.
How does the loan term affect repayments?
A shorter term gives you fewer years to pay back the debt. At the same rate, the payments tend to be larger but the total interest is less. A longer term gives you more payments over which to spread that same debt.
Extra payments can cut interest and the time needed to clear the loan, if your terms allow them. A fixed rate loan may limit extra payments. It may also charge break costs, which are fees for changing or paying out that fixed loan early.
How does this differ from interest-only borrowing?
Principal and interest payments start to cut the debt from the outset. In an interest-only phase, the payments due cover just interest. The amount borrowed stays the same unless you pay extra.
For the same debt, rate and full term, a principal and interest payment is usually larger at first. But it also pays down debt. If the home's value holds steady, this builds equity, which is the value left after the debt.
Illustrative example4 steps
The two parts of one repayment
- Balance at the start of the payment period: $310,000.
- An assumed $2,000 repayment covers $1,400 interest and $600 principal.
- Remaining principal: $310,000 minus $600 = $309,400.
- The debt falls by $600, even though $2,000 leaves the borrower's bank account.
For investors
Debt reduction is a cash cost, even when it is not deductible.
A rental cash budget must cover the whole loan payment. Your tax return has a different split. Eligible interest may be claimed, while paying back debt cannot be. You can have rental profit for tax but little cash left once you make the loan payments. Your accountant can check how much interest you can claim and work out the rental result.
Common questions
Questions about P&I
Keep learning
Property is a complex world.
Principal and interest loan is one piece of it. Lending rules decide how much you can borrow, and how soon you can buy again. Next, read about interest-only loan, offset account and redraw facility.
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