Interest Only vs Principal & Interest Calculator

Interest-only lowers the repayment you make today and raises the amount you pay across the life of the loan. That is the whole comparison in one sentence, and everything below is detail on how much and why.

The step-up is the part to look at

During an interest-only period the balance does not reduce. When the period ends, the loan converts to principal and interest, and the principal now has to be repaid over a shorter remaining term. The repayment steps up twice over: once because principal is being repaid at all, and again because there are fewer years left to repay it in.

Look at the reverted repayment before you look at the saving. If that figure does not fit a realistic budget in five years' time, the structure is borrowing from a future you.

Interest-only is often priced higher

Lenders commonly charge more for interest-only than for principal and interest on an otherwise identical loan. If you are comparing them, use the actual rate offered for each rather than one rate for both.

• Both rates hold for the whole term being compared.
• The loan reverts to principal and interest at the end of the interest-only period and runs to the original maturity date.
• No extra repayments are made and no offset balance is held during the interest-only period.
• The interest-only period is not extended.
• Fees are excluded unless you entered them.

That fourth assumption is worth testing against your own intentions. Rolling an interest-only period a second and third time is common, and each roll makes the eventual step-up sharper.

• The tax position. For investment lending, the treatment of interest is a matter for a registered tax agent and it is often the reason interest-only is chosen at all.
• Any change in property value, which affects equity independently of the balance.
• Rate movements during and after the interest-only period.
• Lender policy limits on interest-only terms, which change over time.
• Whether you will still qualify to extend or refinance when the period ends.
• Fees for switching repayment type mid-loan.

The risk that gets underestimated is qualification risk. An interest-only period ending is not itself a problem. An interest-only period ending at the same time as a business downturn, a valuation drop or a policy tightening is a problem, because the usual escape route is a refinance and refinancing needs a lender to say yes.

1. 01Write down the reverted repayment and test it against a realistic future budget.
2. 02Decide in advance what the interest-only period is buying you, and what has to be true by the time it ends.
3. 03Ask your accountant about the structure if the loan is for an investment or a business.
4. 04Diarise the end date now, and start reviewing options a good six months before it arrives.
5. 05If interest-only is being used to survive rather than to structure, look at whether consolidation solves the underlying problem instead.

If cash flow is the real issue, say so and we will look at it directly rather than papering over it with a repayment type.