Key takeaways:
Your repayments can increase when an interest-only period ends because you start repaying principal and interest.
The remaining loan term affects your new repayment. You generally need to repay your outstanding balance over the remaining loan term.
Preparing early can help you manage the change. Confirm your new repayment, test it against your budget and review your loan before the switch.
If the new repayment is difficult to manage, you may have options, including reviewing your loan term, refinancing or seeking hardship assistance, subject to lender criteria.
Property investors should separate loan structure from tax treatment. Interest deductibility generally depends on how you use borrowed funds, not whether repayments are interest-only or principal and interest.
When an interest-only period ends, a home loan generally switches to principal and interest repayments. Because you start repaying the loan principal as well as interest, your required repayments can increase.
Preparing early can give you time to understand the new repayment amount, adjust your budget and review your home loan options. Whether your interest-only period is ending soon or you're considering switching early, this guide covers:
What changes when you switch from interest-only to principal and interest
Why your required repayments may increase
How automatic and voluntary switches work
How to prepare for the change
What options may be available if the higher repayments are difficult to manage
What property investors should consider, including potential tax implications.
Understanding these factors before you switch can help you plan for the repayment change and decide whether your current home loan still suits your circumstances.
You might also be interested in: What are interest-only home loans?
What does switching from interest-only to principal and interest mean?
Switching from interest-only to principal and interest changes how your required home loan repayments are allocated.
Interest-only repayments | Principal and interest repayments |
Your required repayments generally cover the interest charged, without reducing the principal through scheduled repayments. | Each required repayment covers interest and repays part of the principal, gradually reducing your outstanding loan balance. |
The key difference? Once principal and interest repayments begin, you are paying down the amount borrowed as well as covering interest. This is one reason your required repayment may increase.
Why does my repayment increase when my interest-only period ends?
Your required repayment can increase at the end of an interest-only period for two main reasons: you start repaying principal as well as interest, and you generally need to repay the outstanding balance over the remaining loan term.
For example, with a 30-year home loan that includes a five-year interest-only period, you would generally need to repay the outstanding principal over the remaining 25 years once principal and interest repayments begin.
Your interest rate can also affect the size of the change. If your rate changes around the same time, your new repayment will reflect both the repayment structure and the applicable interest rate.
Example: Interest-only vs principal and interest repayments
Consider a hypothetical $500,000 home loan with a 30-year term and a five-year interest-only period:
Interest-only period | Principal and interest period | |
Outstanding balance at start of period | $500,000 | $500,000* |
6.00% p.a. | 6.00% p.a. | |
Remaining loan term | 30 years | 25 years |
Illustrative monthly repayment | $2,500 | Approximately $3,222 |
In this example, the required monthly repayment increases by about $722, even though the interest rate is the same. The increase reflects the need to start repaying the principal over the remaining 25 years.
*This example is illustrative only and assumes a constant 6.00% p.a. interest rate, monthly repayments and no fees or other loan changes. Assumes only the required interest-only repayments were made during the five-year interest-only period, with no other changes to the loan balance. Actual repayments will depend on factors including your loan balance, interest rate, repayment frequency, remaining term, fees and lender calculations.
How does the switch to principal and interest happen?
The switch can happen automatically when your agreed interest-only period ends, or earlier if you ask your lender to change your repayment type.
The process depends on your loan terms, lender and product.
When your interest-only period ends
Your loan will generally switch to principal and interest repayments when the interest-only period specified in your loan terms expires. Before the change takes effect:
Check your interest-only end date in your loan documents or with your lender.
Review any notices from your lender about the upcoming change.
Confirm your new repayment amount and start date so you can adjust your budget ahead of time.
Check your loan terms for any other changes that may apply.
When you switch early
If you want to move to principal and interest repayments before your interest-only period ends, contact your lender to confirm whether you can make the change and what it involves. Before switching, confirm:
When the new repayments would start
Your new required repayment amount
The interest rate that would apply
Whether any fees or charges apply
Whether any loan features or terms would change.
How can I prepare before my repayment changes?
Preparing before your principal and interest repayments begin gives you time to understand the impact on your budget and review your home loan options. Moneysmart recommends checking when your repayments will increase and by how much.
These six steps can help you prepare.
Senior Aussie Mobile Broker, Joshua Barry says one of the biggest risks is leaving the review too late.
“A common mistake is not planning ahead and being caught off guard when repayments increase as the loan moves to principal and interest,” Joshua says.
“I recommend reviewing your position well before the interest-only period ends. Understanding what your new repayments may look like, and what options are available, can give you more time to prepare.”
1. Confirm when your interest-only period ends.
Check your loan documents, online banking or lender correspondence for the end date. If you're unsure, contact your lender. This gives you a clear timeframe to prepare before the new repayments start.
2. Check your expected principal and interest repayment.
Ask your lender to confirm your expected repayment amount and when it will take effect. You can also use a home loan repayment calculator to compare scenarios, but remember that calculator results are estimates and your lender will determine your actual repayment.
3. Test the new repayment against your budget.
Compare the expected repayment with your household income, regular expenses, other debts and upcoming financial commitments. This can help you see whether your budget can support the higher repayment and where you may need to adjust.
4. Consider increasing your repayments beforehand.
If your loan allows extra repayments, gradually paying more before the switch may help you adjust to the higher repayment amount. Check your loan terms first, as limits, fees and conditions for additional repayments can vary.
5. Check your offset and redraw arrangements.
If your loan has an offset account or a redraw facility, confirm whether anything will change when your interest-only period ends. Check access arrangements, fees and whether an offset account needs to be relinked to the loan.
You might also be interested in: What home loan features can you add to your mortgage?
6. Review your current loan and refinancing options.
The end of an interest-only period can be a useful time to check whether your existing loan still meets your needs. If you're considering refinancing, compare more than the advertised interest rate. Look at the comparison rate, repayments, fees, loan features and switching costs.
Remember: Refinancing may not suit everyone and depends on lender eligibility and lending criteria.
When could switching to principal and interest early make sense?
Switching early may be worth considering if your financial position or property goals have changed since you started the interest-only period. Whether it suits you will depend on your circumstances and objectives.
Joshua says switching earlier may suit some borrowers who have room in their budget for higher repayments.
“If you can comfortably manage the higher repayments, moving to principal and interest earlier means you start reducing your loan balance sooner,” he says.
“Depending on your loan, rate and circumstances, this may also reduce the total interest you pay over the life of the loan. It can also give you time to adjust your budget before the interest-only period ends.”
You may consider switching early if:
You want to reduce your loan balance sooner. Principal and interest repayments start paying down the amount you borrowed.
Reducing debt is now a priority. Paying down principal can increase your equity, although your property's market value will also affect how much equity you have.
Your repayment capacity has changed. Higher income, lower expenses or fewer financial commitments may mean you can accommodate principal and interest repayments.
You no longer need the same cash-flow flexibility. If lower required repayments are less important than when you took out the loan, you may prefer to start reducing the principal.
Your property or investment strategy has changed. Your original reasons for choosing interest-only repayments may no longer align with your current plans.
Before switching, consider how the higher required repayments would fit your budget and check the rate, fees and loan terms that would apply.
What does switching to principal and interest mean for property investors and tax?
For property investors, switching from interest-only to principal and interest repayments does not, by itself, determine whether loan interest is tax deductible. The tax treatment generally depends on how you use the borrowed funds and your individual circumstances.
The principal and interest components are treated differently:
Interest: Some or all of the interest may be deductible where the borrowed funds are used to earn assessable income, subject to your circumstances.
Principal: Repayments that reduce the principal amount of the loan aren't tax deductible.
Loan purpose: If borrowed funds are used for both income-producing and private purposes, interest expenses generally need to be apportioned.
Repayment type: Switching to principal and interest does not, on its own, change whether the interest component is deductible.
Tax treatment can become more complex if you have refinanced, redrawn funds or used the loan for multiple purposes. For example, redrawing funds for a private purpose can affect how much of the loan interest is deductible. See our guide to investment property tax and negative gearing for general information and speak with a registered tax adviser about your circumstances.
What if you can't afford the new principal and interest repayment?
If your new principal and interest repayment looks difficult to manage, contact your lender early. Depending on your circumstances and your lender's criteria, you may have options to consider.
Option | What to consider |
|---|---|
Talk to your lender early. | Ask what options may be available before the higher repayment takes effect. |
A longer loan term may reduce required repayments, but could increase the total interest paid over the life of the loan. Lender approval and criteria apply. | |
Apply for another interest-only period. | You may be able to apply for another interest-only period, subject to lender approval, eligibility and loan terms. Extending an interest-only period may require a new serviceability assessment against the lender’s current criteria. |
Another loan may offer a different rate, repayment structure or features. Compare rates, fees, switching costs and features, and remember that refinancing requires a new application and lender approval. | |
Ask about hardship assistance. | If you're experiencing financial difficulty, contact your lender's hardship team as early as possible. The assistance available will depend on your circumstances. |
ASIC's Moneysmart recommends contacting your lender if you're struggling with repayments.
Joshua says it can help to look at the numbers before the higher repayment takes effect.
“The first step is to look at the new repayment, your income and your overall household budget, rather than waiting until the change takes effect,” Joshua says.
“If the higher repayment is likely to put pressure on your budget, speaking with your lender or a mortgage broker early can help you understand what options may be available and plan your next steps.”
If you give your lender a hardship notice, it must respond within the timeframes set out under the National Credit Code. Your lender does not have to agree to a particular change, and the assistance available will depend on your circumstances.
Review your home loan before or after the switch
You don't need to wait until your interest-only period ends to review your home loan.
Checking your options beforehand can help you understand the repayment change and whether your current loan still suits your circumstances.
If you've already switched to principal and interest, you can still review your rate, loan features and repayment structure. Depending on your circumstances, refinancing may also be worth considering, subject to lender eligibility and lending criteria.
An Aussie Broker can review your existing home loan, explain your options and help you compare relevant refinancing options.