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Home loan repayments: principal and interest vs. interest-only

Girl shrugging about whether to make principal and interest or just interest-only mortgage repayments.

When paying off your home loan, you’ll be able to choose between two mortgage repayment options: principal and interest (P&I), or interest-only (IO). 

Which one you go with will depend on your reasons for buying the property in the first place, along with your financial circumstances.

So let's break down what these home loan terms mean, and how they're useful for owner-occupiers and property investors. 

Home loan principal vs. home loan interest

The principal and the interest are the two main parts of your home loan repayments.

  • Your principal is the initial loan amount you borrowed to buy the property.
  • Your interest is the lending rate charged on your outstanding principal (calculated daily).

As the name suggests, principal & interest home loans require borrowers to pay off their principal balance in chunks and the interest it accrues at the same time. 

Principal & interest repayments are more expensive than interest-only repayments. However, by paying off the principal loan balance, you're growing home equity in the property and lowering the amount of interest you'll pay in the long run. 

How to lenders calculate principal & interest?

When you take out a home loan, your lender will calculate the minimum principal and interest repayments you’ll be required to over the life of the loan. Each lender does this slightly differently.

In general, your lender calculates your minimum mortgage payments by "amortising" (dividing) your principal over your chosen loan term (typically no more than 30 years) at the intervals you request (fortnightly vs. monthly), then adding interest.

Interest is usually calculated daily by multiplying the interest rate against your remaining principal balance. Monthly mortgage repayments typically include 30-31 days of interest.

This is why making extra repayments can save you interest: your interest rate is calculated against a smaller principal each time.

Advantages of principal and interest repayments

Making principal and interest repayments comes with a few important pros.

  • Lower interest rates. Paying both the principal and interest on a home loan makes you less of a risk in banks’ eyes since you're increasing the level of security in the mortgage, so you’ll be offered cheaper rates than you would be on equivalent interest-only home loans.
  • Pay less interest overall. Since your scheduled repayments chip away at both the principal loan amount and the interest owed, you’ll wind up paying less interest over the life of the loan than you would with an interest-only loan.
  • Grow home equity. Because you're making repayments against the actual value of your property, you grow the value of your ownership. This value is called home equity. Your home equity can be used to do many things, like refinance, buy an investment property, or renovate.

What are interest-only loans?

On an interest-only loan, borrowers will pay down just the interest portion along with any associated lender fees for a fixed amount of time (usually no more than five years).

Since your repayments won’t go towards paying off the principal, your outstanding loan balance will remain the same unless you choose to make extra repayments. 

Once the interest-only period expires, you’ll have to start making principal and interest repayments, which can be significantly higher depending on how many years remain on your loan. 

Pros and cons of interest-only home loans

While interest-only loans tend to be associated with property investors (particularly those who want to renovate the property and sell again, see capital gains tax for investors), they can also be useful for other types of borrowers, too.

Here are just a few ways that you can benefit from making interest-only repayments – and some traps to look out for. 

Advantages of interest-only repayments

  • Smaller repayments. If your budget suddenly tightens or you lose an income stream, switching to interest-only repayments for a period of time can provide significant, albeit temporarily, financial relief.
  • Tax incentives. If you’re a property investor, interest-only loans can help maximise cash flow and free up money for further investment, such as a second property or a "flipped" property. You’ll also be able to claim tax deductions against the interest paid on your loan.

Disadvantages of interest-only repayments

  • The principal stays the same. While your mortgage repayments will be lower for the time being, the principal amount will continue to collect interest, which means you’ll pay more over the life of the loan. 
  • You’ll have to make up the repayments. Once the interest-only period ends, your lender will adjust the terms of your loan to make sure you’re still able to pay it off in time. The sudden jump in mortgage repayment size might come as a shock if you’re not prepared.

Home loan interest rates for owner-occupiers and investors

Different home loans types have different interest rates. This is because lenders view home loans by borrower type. Riskier borrowers often pay higher interest rates.

Fun fact, this is why home loans with loan-to-value ratios (LVRs) at 80% or under tend to have cheaper interest rates: the borrower has more security built into their mortgage. 

Let's look at the current averages in the Mozo database for different kinds of home loan borrowers, including what types of repayments they're making.

  • Average owner-occupier principal & interest rate: 6.84% p.a.
  • Average owner-occupier interest-only rate: 7.45% p.a.
  • Average investor P&I rate: 7.18% p.a.
  • Average investor IO rate: 7.45% p.a.

Rates current as of 20 December 2023.

Confused? Here is why investors pay higher interest rates

FAQs about principal and interest

What is principal and interest?

The principal is the total amount of money you borrow. Meanwhile, interest is a fee your loan accrues over its lifetime. Typically, you pay both off at the same time.

Lenders make money off a home loan through the interest accrued.

How to calculate principal and interest repayments?

If you’re trying to calculate principal and interest repayments, you can use an interest calculator. If you’re into maths and want to do the calculations yourself, we list the steps in our Calculate Interest on Loan guide. 

It’s a bit of a lengthy process, so make sure you have plenty of paper.

Is it better to pay principal and interest?

By making principal and interest repayments, you’ll have the chance to pay off your loans quicker and pay less interest overall. This is the way to fully pay off and discharge your mortgage.

You also may be given a lower interest rate if you choose a principal and interest home loan.

If you choose an interest only loan, your principal stays the same, and it might take longer to repay the entire loan.

What gets paid first, principal or interest?

When you make a repayment towards your home loan, both principal and interest get paid at the same time. That means your money splits and covers a bit of the interest and principal.

Assuming your interest rate doesn’t change, your total loan balance goes down with each repayment until you pay it off.

If extra repayments are in your budget, consider adding a bit of extra money so you can repay the loan faster.

Use our mortgage repayments calculator to determine how much you would pay under home loans of different types. 

Browse great value home loans using our home loan comparison page.

Compare home loans - last updated 28 May 2024

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Evlin DuBose
Evlin DuBose
RG146
Senior Money Writer

Evlin, RG146 Generic Knowledge certified and a UTS Communications graduate, is a leading voice in finance news. As Mozo's go-to writer for RBA and interest rates, her work regularly features in Google's Top Stories and major publications like News.com.au.

Niko Iliakis
Niko Iliakis
Money writer

Niko has three years experience as a finance journalist. He specialises in home loans, business loans and interest rate movements at Mozo.

* WARNING: This comparison rate applies only to the example or examples given. Different amounts and terms will result in different comparison rates. Costs such as redraw fees or early repayment fees, and cost savings such as fee waivers, are not included in the comparison rate but may influence the cost of the loan. The comparison rate displayed is for a secured loan with monthly principal and interest repayments for $150,000 over 25 years.

** Initial monthly repayment figures are estimates only, based on the advertised rate. You can change the loan amount and term in the input boxes at the top of this table. Rates, fees and charges and therefore the total cost of the loan may vary depending on your loan amount, loan term, and credit history. Actual repayments will depend on your individual circumstances and interest rate changes.

^See information about the Mozo Experts Choice Home Loan Awards

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