Ever wonder what the difference is between principal and interest home loans and interest-only home loans? If you have, you’re in luck because we have written this article to answer that exact question. Read on to learn the differences between principal and interest payments and how it affects your mortgage. You’ll also learn how to make an informed decision for your own financial situation when choosing the right home loan for you.
Comparing Principal and Interest vs Interest-only Home Loans
So, to compare these two home loan options, let’s first ask what is principal and interest and what is interest-only when it comes to mortgages. To get the answers, let’s define each and outline the benefits of each option.
Principal and Interest Home Loans
Principal and interest home loans are the most common home loans available to prospective home buyers in Australia. It consists of the following:
- Principal – The amount of money you’ve borrowed to purchase a property. This term can also apply to the remaining balance you owe to your bank or lender. As you make payments, the amount is applied to the interest you owe, with the remainder reducing your principal.
- Interest – The interest is the cost of the loan or the fee you are charged for taking out the loan by the lender.
So, when you make payments towards your loan, the amount covers the principal (the original amount you borrowed) and the interest (the fee for borrowing the money).
The Benefits of a Principal and Interest Home Loan
Your home equity increases as you pay off your principal. As you make Principal and Interest (P&I) repayments, you increase equity in the property. Equity is defined as the difference between the property’s market value and the outstanding mortgage balance. This equity can be leveraged for future financial opportunities.
Every time you pay, your loan balance amount reduces. As you make principal repayments, the remaining balance decreases, which in turn lowers the interest charged on future payments.
Lenders view borrowers who choose P&I loans as lower risk. This is because they are actively reducing their debt. As a result, these loans often come with more favourable interest rates
With this type of home loan, you can make extra repayments. This can help to shorten your loan term and reduce the interest you pay. Many loans also offer handy features like offset accounts and redraw facilities, letting you make additional payments and access them if needed.

Interest Only Home Loans
An interest-only loan allows you to make payments covering only the interest of the loan for a specified period. Once this interest-only phase is finished, you transition to paying both the interest and the principal amount of the loan.
While this type of home loan features a lower initial monthly payment, it’s important to note that interest-only loans often come with higher interest rates. And because you’re not reducing the principal during the interest-only period, you also end up paying more interest over the life of the loan.
The Benefits of Interest Only Home Loans
As mentioned earlier, during the interest-only period, your repayments cover only the interest. This results in lower monthly payments compared to principal and interest loans. This can free up cash flow for other expenses or investments.
The reduced repayments during the interest-only term can provide some financial relief. This is useful during periods of reduced income or increased expenses, such as parental leave or educational costs.
For property investors, interest-only loans can be beneficial. The lower initial repayments can improve cash flow, and in some cases, the interest paid may be tax-deductible, potentially enhancing after-tax returns.
Interest Only vs Interest and Principal: Factors That Can Affect Your Choice
If you’re not sure which loan is best for you, here are some factors that can influence the choice between Principal & Interest (P&I) loans and Interest-Only (IO) loans:
- Financial Goals – P&I loans are ideal for reducing debt and owning your property, while IO loans suit short-term cash flow or investment strategies.
- Loan Purpose – P&I loans are better for owner-occupiers, while IO loans are often preferred by investors.
- Tax Implications – Interest on IO loans may be tax-deductible for investment properties, but this doesn’t apply to owner-occupied homes.
- Loan Terms and Conditions – P&I loans provide stable terms, while IO periods are typically limited to 5-10 years.
- Lender Policies – IO loans may have stricter lending criteria or lower borrowing limits compared to P&I loans.
- Market Conditions – P&I loans offer stability, while IO loans depend on favourable property and interest rate trends.
Get The Right Home Loan With Professional Lending Solutions
Not sure which one is the right home loan for you? Choosing between a principal and interest loan and an interest-only home loan is a big decision. To make an informed choice, speaking with a qualified mortgage professional like Phil and the members of our team here at PLS can be a huge help. Get in touch with us today and find out which of these home loan options suits your very specific needs!

Phil’s journey from banking to mortgage brokering reflects a career driven by a commitment to personalised service and tailored financial solutions. With a distinguished background in banking, including roles at NAB, ANZ and Lloyds TSB Bank in the UK, Phil spent 12 years developing expertise in personal and commercial finance, while also completing a Bachelor of Business (Finance), followed by an MBA majoring in International Business.