What’s the difference between principal and interest and interest-only repayments?

A principal and interest (P&I) loan requires each repayment to cover the interest charged for the period plus an amount that reduces the loan’s principal — what you actually owe — so the balance falls with every repayment. An interest-only (IO) loan requires repayments that cover only the interest charged during a set IO period; the principal isn’t reduced at all during that time. Once the IO period ends, the loan reverts to principal and interest over whatever term remains, so the repayment amount typically rises — the same principal now has to be repaid over a shorter remaining period.

How does a principal and interest loan work?

A principal and interest repayment = interest charged on the outstanding balance + an amount that reduces the balance itself.

Early in a P&I loan, more of each repayment goes toward interest, because the outstanding balance — and therefore the interest charged on it — is at its highest. As the balance falls, a growing share of each repayment reduces the principal instead, which is the standard amortisation pattern behind most Australian home loans.

How does an interest-only loan work?

During the IO period, the repayment covers the interest charged on the loan and nothing else — the balance you owe at the end of the period is the same as at the start. IO periods are commonly used by investors, or by owner-occupiers wanting temporarily lower repayments, but the trade-off is structural rather than a one-off cost: because the principal hasn’t reduced, the same original amount is repaid over a shorter remaining term once the IO period ends, and the repayment increases accordingly.

How do lenders assess interest-only loans?

Lenders assess all home loan applications, including interest-only ones, under the responsible lending framework in ASIC’s RG 209 and prudential guidance from APRA (APG 223). As at July 2026, that guidance describes an interest-rate buffer of at least 3.0% applied over the loan’s actual rate (see our guide to the interest rate buffer) — used to test whether a borrower could still meet repayments if rates rose — applied to new and existing debts generally, not as a rule unique to interest-only loans.

Beyond that general framework, individual lenders set their own policies on which borrowers can access an interest-only period, how long it can run, and exactly how the higher post-IO repayment is factored into their assessment — these specifics vary by lender and aren’t laid out in one public rulebook.

What should a first home buyer weigh between the two?

Factor	Principal and interest	Interest-only
Loan balance during the period	Falls	Stays the same
Repayment now	Higher	Lower
Repayment after the period	Stable, rate aside	Rises when IO ends
Total interest, all else equal	Lower over the loan	Higher over the loan

That last row assumes the same loan amount, interest rate and loan term under both structures — a P&I loan starts repaying principal from day one, so, all else equal, less total interest accrues over the life of the loan; changing the rate, term or amount changes the comparison.

There’s no single right choice — it depends on factors including how the lower IO repayment would actually be used, how confident you are in managing a higher repayment once the IO period ends, and how the interest-rate buffer discussed above applies to your own borrowing capacity under each structure. A licensed mortgage broker can model both structures against your actual numbers and your lender’s specific policies.

However you structure the loan, it still sits on top of the deposit question — see our guide to how much deposit you need for a first home in Australia for the paths available, and our guide to how lenders calculate borrowing capacity for how the repayment itself gets assessed.