What the two structures actually mean
With principal and interest (P&I), every repayment covers two things: the interest on your outstanding balance, and a slice of the actual amount you borrowed. Early on, most of the payment is interest. As the balance shrinks, more of each payment goes to principal, until the loan hits zero at the end of the term.
On a $600,000 investment loan at 6.5% P&I over 30 years, your monthly repayment is around $3,792. In year one, roughly $3,250 of that is interest and $542 is principal reduction.
With interest only (IO), you pay just the interest, nothing goes towards the principal, and the balance stays flat for the IO period, typically one to five years, occasionally up to ten with some lenders. At the end of that period the loan either reverts to P&I over the remaining term (which means higher repayments), or you negotiate a fresh IO period.
On the same $600,000 loan at 6.5% IO, the monthly repayment is around $3,250, about $542 less than P&I. That's $6,504 a year in lower repayments. But it's worth being blunt about what that buys you: IO doesn't reduce your debt. After five years of IO repayments you still owe the full $600,000. A P&I borrower over the same five years has brought the balance down to around $573,000.
The cashflow case for interest only
The main reason investors choose IO is cashflow. Lower mandatory repayments mean more money each month, which you can redirect to an offset account, another investment, renovations, or simply as a buffer for vacancy or unexpected costs.
That's not an irrational position. Property investment is mostly a capital growth game. If the property is growing at 5% to 7% a year, the principal you're not paying down is appreciating anyway, so the logic runs: why pay the debt down quickly if the asset is growing faster than the debt costs you?
The after-tax cashflow gap is the number that actually matters. At current investment loan rates of around 6.5%, the interest on a $600,000 loan is about $39,000 a year, and every dollar of it is deductible. On the 37% marginal rate, the ATO effectively covers $14,430 of that bill through your tax return.
Why P&I isn't automatically the wrong choice
Here's the counterintuitive bit most borrowers miss: interest only loans typically carry a rate 0.10% to 0.30% higher than comparable P&I loans, so some of the extra deductible interest you gain from IO is clawed back by the higher rate you're paying for it.
P&I also builds equity, and equity is the raw material for your next purchase. If your plan is to build a portfolio, paying down the balance on property one increases your usable equity, and your ability to use it as a deposit on property two without refinancing.
There's a less obvious advantage too: P&I forces discipline. The extra cashflow from IO only helps you if you actually put it somewhere productive, an offset, another investment, savings. A lot of investors just spend it. The lower P&I repayment builds the savings habit automatically, whether you mean it to or not.
How the tax position changes between the two
The ATO taxes rental income and allows deductions for expenses including loan interest, property management, rates, insurance and depreciation. The interest deduction is where IO and P&I diverge over time. With IO, the deduction stays flat across the IO period, since the balance isn't shrinking. With P&I, the deduction falls each year as the principal reduces.
In practice, over a five-year IO period, an investor on the 37% bracket typically receives $2,000 to $5,000 more a year in tax savings on a $600,000 loan compared to P&I, depending on the rate gap. That's real money, but it has to be weighed against the fact the principal isn't moving during that period.
A worked example: $600,000 loan, 6.5%, 37% bracket
Take a $600,000 investment loan at 6.5% over 30 years, with a five-year IO period before reverting to P&I. The property rents for $550 a week, and annual holding costs (rates, insurance, management, maintenance) run $8,000 excluding interest.
Under P&I, annual rent is $28,600, first-year interest is around $38,350, other costs are $8,000, giving a pre-tax annual shortfall of $17,750. At 37%, the tax saving is $6,568, leaving a real after-tax shortfall of $11,182 a year, or $215 a week. The monthly repayment is $3,792, and after five years the balance sits around $573,000.
Under IO, the same $28,600 in rent meets $39,000 in interest and $8,000 in other costs, a pre-tax shortfall of $18,400. The tax saving at 37% is $6,808, leaving a real after-tax shortfall of $11,592 a year, or $223 a week. The monthly repayment is $3,250, and after five years you still owe the full $600,000.
The after-tax gap between the two structures on this property works out to roughly $8 a week, far smaller than the $542-a-month headline difference suggests. What actually determines whether IO wins depends on where that monthly saving goes. If it lands in an offset account against your home loan, saving you 6.0% home loan interest tax-free, IO comes out ahead. If it disappears into everyday spending, P&I is the better discipline.
When interest only makes sense
IO tends to be the stronger choice when most of the following apply to you: you've got a mortgage on your own home and want to direct every spare dollar there instead, since that debt isn't deductible and the investment interest already is; you expect strong growth on the property, so the modest after-tax cost of holding IO debt is worth it against the capital gain; you're on the 37% or 45% tax bracket, where the ATO is subsidising a large share of the interest bill (at 45%, it covers $17,550 of a $39,000 bill on a $600,000 loan, nearly half); you're planning to sell within five to seven years, where the exit is a capital gain rather than a long-term income stream; or you have a genuine plan for the monthly saving rather than letting it drift into spending.
When principal and interest makes sense
P&I tends to be the better fit if you own your home outright and have no non-deductible debt to prioritise; if you're on a lower tax bracket like 32.5%, where the IO tax benefit is more modest and the discipline of paying down principal outweighs the cashflow saving; if APRA has tightened IO lending (which happens periodically) and the rate premium for IO has pushed above about 0.25%, weakening the case for it; or if you're planning to hold long-term and want your rental yield to grow against the original purchase price as the loan balance falls.
The lender and APRA context, April 2026
At April 2026, investment IO rates from the major lenders sit around 6.60% to 6.90% depending on LVR and lender, against investment P&I rates of roughly 6.40% to 6.70% for the same profile. The current 0.10% to 0.30% gap sits at the lower end of its historical range.
IO terms on investment loans typically run one to five years, occasionally up to ten. At the end of the term, the loan reverts to P&I over whatever's left, so a five-year IO period on a 30-year loan means 25 years of P&I repayments afterwards, higher than they'd have been spread over the full 30. Lender policy on repeat IO periods also varies: some allow consecutive IO terms subject to reassessment, others require a stint on P&I first. It's a negotiation that goes more smoothly with a broker who knows each lender's approach.
What banks don't always volunteer
Banks have a mild conflict of interest here. Interest only loans give the bank more predictable revenue, a steady interest payment with no principal erosion in the early years. A recommendation from bank staff isn't necessarily built around what's best for you.
A broker's incentive is structured differently, and worth being honest about too: brokers are paid trailing commission on the outstanding balance, which means a broker recommending IO on the investment while you pay down the home loan first is recommending a structure that keeps both balances higher for longer. That's only the right call if it genuinely suits your tax position and strategy, which is why the recommendation should be built around your full financial picture, not a rule of thumb.
Five questions to ask before choosing
Do you have a non-deductible home loan?
If yes, IO on the investment with maximum repayments on the home loan is almost always the better structure.
What's your marginal tax rate, and is it likely to change?
A pay rise, a business, or a move to part-time work all shift the calculation.
What will you actually do with the cashflow saving from IO?
Be honest. If the answer is "put it in my home loan offset", IO makes sense. If the answer is vague, P&I forces the discipline you need.
What's the IO rate premium at the lenders you qualify for?
Above about 0.25%, the tax benefit narrows and the case for IO weakens.
And what's your exit or hold strategy?
IO suits a capital growth play with a defined exit. P&I suits a long-term hold where yield and equity matter more.
How Stanford Financial structures investment loans
When a client comes to us about an investment purchase, the first conversation isn't about rates. It's about structure: which split between IO and P&I, which account type for each, how to maximise the deductibility of the investment loan while minimising the home loan balance. Getting that right is worth more over time than any single rate negotiation.
We compare interest only investment loan options across more than 50 lenders, including specialist investment lenders that don't advertise to the public. We model the after-tax cashflow position at your income level, and flag the APRA policy settings and IO term limits at each lender, so there are no surprises when the IO period ends.
If you're weighing up an interest only investment loan, or want to review your current structure, book a free 30-minute assessment for a clear picture of the right structure for your situation.
Call us on 0483 980 002 or book a free assessment online.
