Interest-only versus principal and interest repayments

Different loan repayment types

When you apply for a home loan, you may have the option of one of these repayment types:

• principal and interest repayments
• interest-only repayments

It’s important to understand how these different types of loan repayments work and how they can change over time. Each have their advantages and disadvantages.

What is the ‘principal’ and what is ‘interest’?

Your home loan is made up of two parts: the principal and the interest.

• The principal is the amount you borrow.
• The interest is the amount you're charged by the lender for borrowing the principal amount.

Here’s what you need to know about the two most common types of loan repayments.

Principal and interest repayments

If you have this type of home loan, you’ll need to pay both the principal as well as the interest charged on it.

Advantages of a principal and interest loan

• pay less interest over the life of the loan
• pay a lower interest rate compared to interest-only rates for an equivalent home loan
• pay off your loan faster, so you'll own your property outright sooner.

Disadvantages of a principal and interest loan

• repayments are higher than interest only
• may not be as tax-efficient for investment loans.

Interest-only repayments

This is when you only pay the interest portion of your loan for a set period, for example the first five years of your loan.

As you’re not making payments on the ‘principal’, this will remain the same, unless you choose to make additional repayments.

At the end of your interest-only period, you’ll need to start paying off the principal at the current interest rate at that time.

While interest-only repayments are lower during the interest-only period, you’ll end up paying more interest over the life of the loan.

Advantages of interest-only loans

• lower mortgage repayments for a limited time to suit your lifestyle (e.g. taking time off work to be a primary carer)
• possible tax benefits for investment loans.

Disadvantages of interest-only loans

• principal amount will not reduce during interest-only period
• higher repayments once the interest-only period finishes
• higher interest rate during interest-only period
• more interest payable over the life of the loan.

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.

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.

Changing your home loan repayment type

If you already have an interest-only NAB home loan which is about to expire and want to talk about your options, call us on 13 22 65 today.