Principal and interest vs. interest only home loans - NAB
Interest only vs. principal and interest repayments
- Interest only repayments cover only the interest charged on your loan for a set period.
- Principal and interest repayments reduce both your loan balance and the interest charged.
- Interest only repayments are usually lower initially.
- Principal and interest repayments help build equity sooner.
- Interest only home loans generally cost more over the life of the loan.
Watch our video to learn more.
What is the loan ‘principal’ and what is the ‘interest’?
Your home loan is made up of two parts: the loan principal and the interest.
The loan principal is the amount you borrow to fund your property purchase. This is the difference between the full cost of the property and your deposit.
The interest is the amount you're charged by the lender for borrowing the principal amount.
What is an interest only home loan?
With an interest only home loan, you make repayments that cover only the interest charged on the amount you've borrowed for a set period, usually at the start of the loan term.
During this period, your loan balance (or principal) generally stays the same unless you make additional repayments.
Whether interest only repayments are suitable will depend on individual circumstances, financial goals and risk tolerance.
Principal and interest home loan
If you have this type of home loan, you’ll need to pay both the principal as well as the interest charged on it.
To begin with, you’ll mostly pay interest. But as time passes and you chip away at the loan, you’ll start paying a greater percentage of the principal.
What happens when an interest only period ends?
At the end of the interest only period, repayments typically switch to principal and interest.
This means you'll begin repaying both the loan balance and the interest charged.
Because the remaining balance must be repaid over the rest of the loan term, repayments are often higher than they were during the interest only period.
For example, if a borrower has a 30-year loan with an interest only period for the first five years, the remaining loan balance would typically need to be repaid over the remaining 25 years. This can lead to a noticeable increase in repayments.
Understanding how your repayments may change can help you plan ahead.
Case study of two loan repayment types
See how the two types of loans affect John and Rebecca's repayments.
John and Rebecca have a loan of $500,000 and are deciding which repayment option is suitable for them.
The table shows the difference in interest they will pay over the life of their loan.
| Principal and interest for life of loan | Interest only for first five years | |
|---|---|---|
| Interest rate | Principal and interest for life of loan 4.39% | Interest only for first five years 4.39%
|
| Loan size | Principal and interest for life of loan $500,000 | Interest only for first five years $500,000 |
| Loan term | Principal and interest for life of loan 30 years | Interest only for first five years 30 years |
| Monthly repayments during interest only period | Principal and interest for life of loan n/a | Interest only for first five years $1,829 |
| Monthly principal and interest repayments | Principal and interest for life of loan $2,501 | Interest only for first five years $2,748
|
| Total interest payable | Principal and interest for life of loan $400,307 | Interest only for first five years $434,161 |
| Additional interest paid due to the interest only period | Principal and interest for life of loan $0 | Interest only for first five years $33,854 |
Calculate and compare property loan repayments
We've created a handy home loan repayments calculator to help you calculate and compare your loan repayments. You can change between principal and interest repayments and interest-only repayments to estimate the different interest charges.
Owner occupier vs residential investor loans
These are two terms you’re likely to see when selecting a home loan or when reviewing interest rates.
Owner occupier means the person or persons living in the home own the home.
A residential investor is someone who purchases a residential home (not commercial or business property) for the purpose of renting it out as an investment.
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The information contained in this article is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, NAB recommends that you consider whether it is appropriate for your circumstances. NAB recommends that you seek independent legal, financial and taxation advice before acting on any information in this article.