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When you set up your loan you will often be given the choice of Principal & Interest or Interest Only repayments. But what should you choose and why?

The Exception: When the majority of your debt is for your own home or personal expenses.

If more than 50% of your total loan is used to buy your own home or other personal reasons (eg renovations, holiday, personal expenses) then it is what is known as a ‘regulated’ loan. A regulated loan means that it is regulated under the Consumer Credit Code. Under the Consumer Credit Code any potential lender has additional responsibilities in ensuring that you can reasonably afford to repay both the principal and interest over the life of the loan even making reasonable allowances for interest rates to rise. Accordingly all lenders require regulated loans be Principal & Interest. Even if your loan is not regulated you will be required to indicate and sign off that this is the case to release the bank from such obligations.

It is possible to separate the regulated part of your home loan into its own sub-account and still have interest only for investment. Please refer to the section on ‘Structuring your Loan’ for more information.

Principal & Interest or Interest Only – the decision point

If you have the option of Principal and Interest or Interest Only then it is generally advisable to consider interest only. The logic behind this is that your interest only repayment is always going to be lower than a principal and interest repayment, but with the vast majority of home loans you have the option of making additional repayments at any time without penalty. So with an interest only loan you could CHOOSE to make the same repayment as if the loan was principal and interest, but you have the OPTION of making a lower repayment should you ever go through a cash shortage. However if you select principal and interest from the beginning you are locked in to making the higher repayment. So common sense says you should take the lower minimum repayment of an interest only loan and then you can choose to make additional repayments. The decision whether to make additional repayments or not is addressed in the section ‘Should I make Additional Repayments’.

Some people like to make principal and interest repayments as a way of forced saving. Depending on your personal habits this may be a prudent strategy for many people.