Interest-only vs principal and interest: the later bill

A lower payment can mean principal is not being repaid

A conventional principal-and-interest payment includes borrowing cost and a reduction in the amount owed. An interest-only payment generally leaves that original amount unchanged during the agreed period. The smaller payment is therefore not simply a discount on the same repayment job.

MoneySmart explains that after an interest-only period ends, the loan generally moves to principal and interest, with a higher required payment. The structure, rates and conditions depend on the actual contract. Read both phases rather than judging the loan from the opening payment alone.

Write the outstanding balance beside the payment. A household may feel that five years of payments must have substantially reduced the debt, but that expectation does not fit an interest-only period without additional principal repayments. Keeping the balance visible makes the difference concrete.

Source: MoneySmart: interest-only home loans

Calculate the unchanged-rate jump

Use a fictional $500,000 loan at a constant 6% annual rate with monthly calculations. The simple interest-only payment is $2,500 a month. A principal-and-interest loan repaid over thirty years would instead require about $2,997.75 a month, ignoring fees.

If the thirty-year contract begins with five interest-only years, the remaining $500,000 must then be repaid over twenty-five years under the same simplified structure. At the unchanged 6% rate, that payment is about $3,221.51 a month. The jump from $2,500 is about $721.51.

These are teaching assumptions, not available loan rates or lender quotes. Actual interest is commonly calculated using daily balances. The example isolates a key point: a payment can rise when the interest-only phase ends even if the interest rate does not rise at all.

The term left afterwards matters

A borrower who compares the interest-only payment with a fresh thirty-year principal-and-interest payment at the transition date can understate the contractual increase. Unless the lender agrees otherwise, the remaining term is shorter because the interest-only years have already passed.

An extension or refinance would be a separate application with its own conditions, costs and assessment. Do not build a household budget on the assumption that a lender will automatically offer a new thirty-year term later.

Ask for a schedule showing the phase end date, expected outstanding principal and repayment over the actual remaining term. If the lender illustration uses a different rate or term for the second phase, highlight that difference. A consistent example is easier to compare with the household’s realistic future income.

A higher rate adds another pressure

At 7% over twenty-five years, the fictional $500,000 principal-and-interest payment is about $3,533.90 a month. Compared with the original $2,500 interest-only illustration, that is roughly $1,033.90 more each month. The change combines a higher rate with the shorter repayment period.

This is a stress scenario, not a rate forecast. Test whether the household could meet that amount after annual bills, insurance, maintenance and other debts. A future promotion or increase in working hours should be labelled uncertain unless there is a sound basis to rely on it.

Avoid comparing a best-case current payment with an optimistic future income while excluding other changes. A useful stress worksheet states which costs are fixed, what could be reduced and what happens if income is lower than expected.

Compare the balances as well as total cash paid

During five interest-only years at the fictional unchanged rate, $2,500 paid monthly totals $150,000 while the principal remains $500,000. A principal-and-interest alternative pays more each month but reduces the debt. Total payments alone do not show the difference in equity.

Property-price movements are another separate factor. The home rising in value can increase equity, but it does not mean the loan principal has been repaid. A flat or falling price can leave less room to refinance or sell than an optimistic projection assumes.

Record outstanding debt at the same dates on both paths. If considering a sale, include selling costs and any remaining liability. Do not assume that future property growth is a guaranteed mechanism for clearing the original borrowing.

Be explicit about the money not paid into principal

If the reason for the structure is to direct cash elsewhere, write where the difference will go and what risks apply. Saving it, paying another debt and spending it produce different household outcomes. None happens automatically because a required repayment is smaller.

For illustration, a $400 monthly difference redirected for twelve months is $4,800 before interest or other effects. If only $150 actually reaches the other goal, the realised amount is $1,800. The original projection should not continue assuming $4,800 was accumulated.

This article does not recommend borrowing to invest, a tax strategy or a particular debt allocation. Those choices need a wider assessment. A repayment structure should be evaluated with the actual use of the cash difference, not a hypothetical alternative that the household would not follow.

Tax and security do not determine affordability

An interest deduction, if legally available in a particular income-producing arrangement, does not make borrowing free or ensure that repayments can be met. Owner-occupied and investment-related borrowing can have different tax treatment, and use of funds matters.

Do not select an interest-only arrangement solely because an online example shows a deduction. Obtain current tax advice for the actual borrowing and transactions. Keep the before-tax cash obligations visible even where a later tax effect is expected.

MoneySmart’s choosing-a-loan guidance encourages comparison of rates, fees, features and repayments. Approval is also separate from a calculator result. The lender must assess the actual borrower and property, and an assumed future refinance should remain an unconfirmed possibility until assessed.

Source: MoneySmart: choosing a home loan

Prepare before the transition date

Find the end of the interest-only period now, ask for an updated repayment estimate and test it in the budget. If allowed under the contract, some borrowers may choose to practise setting aside the difference; check any repayment restrictions before sending extra money into the loan.

If the later payment appears unaffordable, contact the lender early about options and appropriate hardship support. Waiting until the first larger payment is missed reduces the time available to investigate. A new loan is not the only possible conversation.

Use MoneySmart’s dedicated interest-only calculator for a phase-based illustration. Elaris’s loan tool can estimate the later principal-and-interest amount using the balance, rate and remaining term you enter, but it does not automatically stitch the two phases together or give a lender-approved schedule.

Also compare the transition date with other commitments. If a known school fee or insurance renewal falls in the first higher-payment month, an average annual budget can hide the immediate shortfall. Put those dates on the same calendar and identify the cash source. The aim is to understand whether the household can meet the larger payment when it actually starts, rather than only demonstrating that an annual income total exceeds an annual expense total.

If an extra principal repayment is permitted and deliberately made, update the debt before recalculating the later schedule. For example, reducing the fictional balance from $500,000 to $480,000 changes the amount on which future calculations are based. At a simple unchanged 6% rate, monthly interest on those balances is $2,500 and $2,400 respectively. The contract determines the required payment and access consequences; this illustration is not permission to exceed a fixed-rate repayment limit or assume redraw remains available.

Sources: MoneySmart: interest-only home loans · MoneySmart: interest-only mortgage calculator

FAQ: Does interest-only mean the loan costs less?

It usually means a lower initial required payment, not proof of a lower total cost. Principal remains outstanding during the interest-only period unless separately repaid. Compare the full term, rates, fees and later payment rather than judging only the first monthly amount.

FAQ: Will the repayment rise even at the same rate?

It can. Once principal must be repaid over the shorter remaining term, the payment increases even without a rate change. The fictional example shows that mechanism. Obtain the actual transition schedule and check the remaining years in the lender’s calculation.

FAQ: Can I refinance when the period ends?

You may be able to apply, but future approval, valuation, rates and costs are uncertain. Do not treat a new loan or term extension as guaranteed. Build a scenario that meets the existing contractual obligation and separately assess any proposed refinance.

FAQ: Does the Elaris calculator model both phases?

No. It uses a standard monthly principal-and-interest formula. You can enter the later balance and remaining term as a separate scenario, while using the official dedicated calculator or lender schedule for the complete interest-only arrangement. Check fees and actual timing independently.

Sources and editorial notes

Sources checked 24 October 2026. Worked examples are fictional illustrations. Rules, eligibility and product terms can change; use the official source for your circumstances.

• MoneySmart: interest-only home loans ↗
• MoneySmart: interest-only mortgage calculator ↗
• MoneySmart: choosing a home loan ↗

General information, not an individual financial or legal assessment. AI-assisted drafting with source checks; independent professional review has not been completed. How we prepare our guides · Suggest a correction