What are interest-only home loans and how can they support cash flow and financial flexibility

What are interest-only loans?

Interest-only loans are a type of mortgage where borrowers pay only the interest on the loan for a specified period, without reducing the principal balance. This results in lower monthly repayments during the interest-only term, freeing up cash flow for other financial opportunities or needs. 

Compared to principal and interest home loans, interest-only loans are often viewed as a less-than-ideal way to pay off a mortgage, as you aren’t reducing the principal balance of the loan, which can mean higher total interest paid over the lifetime of the loan.

However, for some borrowers, refinancing to an interest-only loan may provide short-term cash-flow flexibility that can support broader financial goals - provided risks, costs and repayment strategy are carefully considered.

How can an interest-only loan support rentvesting?

Rentvesting allows you to live where you love while investing in another property that might be more affordable. Interest-only loans can be a helpful sidekick for rentvestors, temporarily offering lower monthly repayments that free up your cash flow to build up your property portfolio.

How does it work? David already has a property and his fixed-rate mortgage is about to roll onto a variable loan, meaning higher repayments. He wants to move out of his property to turn it into an investment, so he refinances to an interest-only loan, which reduces repayments temporarily. Because he’s now using the property as an investment and earning rental income, some or all of the interest may be tax deductible. The rent he earns from turning his property into an investment may also help offset his mortgage repayments – leaving more money to save for future investments.

Key considerations: From 1 July 2027, negative gearing rules for residential property investments will change, so investors should seek tax advice before refinancing or restructuring.

Can an interest-only loan help growing families?

For some growing families, switching temporarily to interest-only repayments may help manage cash-flow pressure during expensive life stages. With lower monthly payments during the interest-only period, you can allocate funds towards other essential needs like education, family vacations or home improvements, giving you the freedom to enjoy life while planning for the future.

How does it work? Maddie and Ryan have just had their first child. They bought their home seven years ago, however would like to reduce their home loan repayments to save money to put toward private school fees. Refinancing to interest-only can drop their repayments temporarily so they can save more and put the funds towards their kid’s education.

Key considerations: For some families, switching temporarily to interest-only repayments may help manage short-term cash-flow pressure. But it also means the loan balance won’t reduce during the interest-only period, and total interest costs may be higher - so it’s important to weigh the short-term relief against the longer-term cost.

How can pre-retirees use an interest-only loan to access equity?

For those thinking about retirement, choosing to unlock the equity in your home and switching to an interest-only loan can free up cash flow compared to a principal and interest loan, meaning you can access additional funds for those long-awaited adventures.

How does it work? Celina and Vic are approaching retirement and have owned their property for 20 years. Their loan has a very low LVR (loan-to-value ratio). They want to access the equity in their home to help their adult child purchase his first home, start a share portfolio and use some money for a European holiday. Their budget is currently comfortable, however they don’t want to have their repayments increase from where they are now from accessing equity in their mortgage with a principal and interest loan. Refinancing to an interest-only loan may allow them to access equity while limiting the increase in repayments.

Key considerations: It’s important to note, by making only interest payments, they won’t be reducing the principal loan amount, therefore won't reduce the balance of their home loan during the interest-only period. This could be a disadvantage if property values decline or if they plan to sell the property during this time. It may also require a clear repayment or exit strategy, especially for borrowers approaching or in retirement.

How do property investors use interest-only loans?

For some property investors, an interest-only loan can create extra breathing space in the budget, making it easier to focus on other financial goals while holding onto an investment property. With repayments focused solely on interest, investors can improve their short-term cash flow, and interest expenses on rental income may be tax-deductible. This strategy can allow investors to expand their property portfolio without the immediate pressure of paying down the principal. If the property increases in value, investors may also benefit from capital growth.

How does it work? Ajay and Paula are approaching retirement. They own their primary residence outright, but still owe about 70% on their investment property. They would like to spend more time travelling before they retire, however doing this while juggling loan repayments is difficult. They would prefer not to sell their investment property at this time, as there is potentially still strong capital growth potential prior to retirement. Switching to an interest-only loan will free up more cash flow compared to a principal and interest loan so they can save faster toward their travel goals. It’s important that refinancing aligns with their long-term financial goals and that they have a solid strategy for managing the eventual increase in repayments once the interest-only loan period expires. 

Key considerations: 2026 tax reforms mean negative gearing will be limited to new builds from 1 July 2027, so the tax outcome depends on the property type, purchase date and individual circumstances.

What are the risks of switching to an interest-only loan?

Switching to an interest-only loan can be a powerful tool for some, but with any financial decision, it’s crucial to consider your individual circumstances and seek professional advice to ensure it aligns with your goals. Some things to remember:

• Once the interest-only period expires, your monthly repayments will increase as you start paying both principal and interest. This can lead to a significant rise in monthly expenses, which could strain your finances if not anticipated.

• Over the life of the loan, you may end up paying more in interest compared to a principal and interest loan. This is because the principal remains higher for longer, resulting in more interest accruing over time. 

• If the property market declines, you may find yourself with negative equity, where the value of your home is less than the outstanding loan amount. This can make it difficult to refinance, sell, or access additional funds.

How do the 2027 tax changes affect interest-only investment loans?

From 1 July 2027, new rules may affect how investment properties are taxed, which could influence the overall value of your investment strategy.

Existing properties held at 7:30 pm AEST on 12 May 2026 are exempt from the negative gearing changes. Capital gains tax (CGT) rules are also changing from 1 July 2027, with the current 50% CGT discount being replaced by cost-base indexation and a 30% minimum tax on capital gains for individuals, trusts and partnerships.

As tax outcomes depend on your individual circumstances, it's a good idea to speak with a registered tax adviser about what these changes could mean for you and your plans