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Understanding principal and interest and interest only repayments

If you’re looking to buy property or refinance your existing loan, you have lots of decisions to make, but here’s a really fundamental one:

What repayment type should you choose for your loan - principal and interest or interest only?

Let’s start by explaining the difference between the two, then diving a little deeper to help you consider your options.

 

What are principal and interest and interest only repayments?

Repaying a loan with principal and interest means each repayment you make pays a part of the principal and the interest charged.

You can choose to make interest only repayments for a specific period of time (usually up to 5 years). During the interest only period, you’re only paying interest charged, meaning the repayments can be lower than principal and interest repayments. However, interest only periods are always limited, because you have to eventually repay the principal balance. At the end of your interest only period, you’ll switch to principal and interest repayments and your repayment amount will be higher.

Choosing an interest only repayment can increase the total amount of interest you pay over the life of the loan. This is because during the interest only period, the principal is not being repaid, yet it continues to accrue interest.

Let’s look at an example

Figures included in this example are estimates only.

Let’s look at an example

Let’s assume you’ve borrowed $500,000 on a 30-year variable loan to buy your home to live in with a 5 year interest only period. Here’s a comparison of what your monthly repayments may look like in the scenarios below:

Repayments for years 1 to 5

Years 1 - 5

Scenario 1

Principal and interest

Years 1 - 5

Scenario 2

Interest only

Years 1 - 5

Interest rate

5.20% p.a.

5.75% p.a.

Estimated monthly repayments (1)

$2,746

$2,396

Difference in monthly repayments

 

-$350

 

Changes in repayments after interest only period ends

Year 6 onwards after the interest only period ends

Principal and interest

Years 6 - 30

Principal and interest

Years 6 - 30

Interest rate

5.20% p.a.

5.20% p.a.

Estimated monthly repayments (2)

$2,746

$2,982

Increase in monthly repayments after interest only period ends (2) - (1)

$0

+$586

 

Repayments over 30 year loan term

Over the 30 year loan term

Scenario 1

Scenario 2

Total interest paid

$488,400

$538,202

Additional interest charges with interest only repayments

 

+$49,802

As you can see in this example, for the first 5 years during the interest only period, your repayments might be lower. But from year 6, after the interest only period ends and your repayments switch to principal and interest, your monthly repayments increase. Also, the total amount of interest you pay over the life of the loan will actually be higher compared to a loan with principal and interest repayments.

 

To estimate loan repayments for your scenario, try our ANZ Home Loan Repayments Calculator.

Some things to consider

Interest only loans are not for everyone and you should consider if this is the right option for you. Here are some things to consider when choosing between principal and interest or interest only repayments. We recommend you obtain individual financial and tax advice with any questions for your situation.

Principal and interest repayments

  • You will be paying down your principal balance from your first repayment
  • You could pay less interest over the life of the loan as your principal balance reduces
  • Currently our interest rates on principal and interest repayments are lower than interest only.

Interest only repayments

  • Generally preferred by customers purchasing an investment property or a property that is expected to be used as an investment in future
  • Investors may be able to claim interest paid as a tax deduction if the loan is to purchase a residential investment property earning rental income
  • Interest only repayments should not be considered solely for lower repayments as interest only periods are limited. After the interest only period, your repayments will switch to principal and interest and your repayments will be higher. You may pay more over the life of the loan.

We’re here to help

Looking for the right loan with ANZ? Talk to our Home Loans Specialists on 1800 100 641 (or +61 3 8646 8108 if you're outside Australia). We are available Monday to Friday 8am - 8pm (AEST) and Saturday and Sunday 8am - 6pm (AEST).

If you already have existing loans with us and would like to switch from interest only to principal and interest repayments you can do so without incurring renegotiation fees associated with switching- call us on 13 25 99 Monday to Friday 8am - 8pm (AEST).

This is general information only and does not constitute tax advice. We recommend you obtain independent  advice from a financial planner and/or registered tax agent if you are considering the right repayment type for you or purchasing an investment property.

All applications for credit are subject to ANZ's credit approval criteria. Terms and Conditions apply and are available on application. Fees, charges and eligibility criteria apply.