Most people default to principal and interest loans because that’s what they’re told to do with their home loan. With an investment property, the aim is usually to manage cash flow, use the tax deductions and put the freed-up capital toward the next property, rather than pay the loan off fast.
Interest-only loans on investment property are a deliberate choice. The maths on a $600,000 loan shows the trade-off, and when it makes sense to switch. After four rate rises in 2026, protecting your cash flow matters more. We cover that angle in our May 2026 RBA decision preview.
The 5-year cash flow comparison
On a $600,000 investment loan at the average rates for new investor loans in July 2026 (RBA table F6), over a 30-year term:
Principal & interest (P&I) at 6.32%:
- Monthly repayment: ~$3,722
- Annual repayment: ~$44,660
- Loan balance after 5 years: ~$560,500
- Total interest paid over 5 years: ~$183,800
- Total principal paid: ~$39,500
Interest only (IO) at 6.50%:
- Monthly repayment: $3,250
- Annual repayment: $39,000
- Loan balance after 5 years: $600,000 (unchanged)
- Total interest paid over 5 years: $195,000
- Total principal paid: $0
The IO loan costs $472 less per month. Over 5 years, that’s about $28,300 in freed-up cash flow. You pay about $11,200 more in total interest over 5 years. The extra cash flow can still matter more than the interest you would save on P&I.
Why the extra interest is worth it
That $472 per month does two useful things, and there is a third that many investors expect but won’t get.
1. It does not lift your borrowing capacity. Lower repayments help you hold the property, but the bank’s number doesn’t improve. Under APRA’s APG 223, banks assess an IO loan on principal and interest over the term left after the IO period. Each loan is tested at its rate plus APRA’s 3 percentage point buffer. The P&I loan at 9.32% over 30 years is assessed at $4,967 a month. The IO loan at 9.50%, with five years IO, is assessed over the remaining 25 years at $5,242 a month. APRA’s debt-to-income limit also counts the full $600,000 either way. From 1 February 2026, lending at 6x income or more is capped at 20% of each bank’s new loans (APRA). For how banks calculate that number in 2026, see our borrowing capacity breakdown.
2. Shrinks the monthly shortfall. On a $600,000 property renting for $550 per week ($2,383/month), the IO repayment of $3,250 leaves a monthly gap of $867. On P&I, the gap is $1,338. That’s a 54% bigger out-of-pocket cost for the same property. For investors holding multiple properties, the cumulative difference determines whether the portfolio is sustainable or a strain.
3. Preserves capital for the next deposit. The $28,300 of lower repayments over 5 years on a single property is a meaningful contribution toward a deposit on property two. If you’re building a portfolio, a faster path to the next purchase matters more than paying down a loan that inflation is eroding anyway.
The tax deduction difference
Interest is deductible and principal is not, and that shifts the comparison.
On an IO loan, 100% of your repayment is deductible. On a P&I loan, only the interest component is deductible. That component shrinks every year as more of each payment goes toward principal.
On the $600,000 example:
- IO deductions over 5 years: $195,000 in deductible interest
- P&I deductions over 5 years: ~$183,800 in deductible interest (declining each year)
- Difference: ~$11,200 in additional deductions on IO
At a 37% marginal tax rate, that $11,200 in extra deductions saves about $4,150 in tax over 5 years. At 45%, it saves about $5,050.
Model your after-tax position with interest-only repayments. See how negative gearing offsets your holding costs.
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When you factor in the tax benefit, the “extra cost” of IO shrinks. You pay about $11,200 more in interest but get back $4,150-$5,050 through lower tax. The net extra cost is about $6,170-$7,060 over 5 years. That is roughly $100-$120 per month, while freeing up $472 per month in cash flow.
The higher your marginal rate, the smaller the after-tax cost of IO. One caveat applies to new purchases. Under Act No. 49 of 2026, losses on established dwellings bought after 7.30pm on 12 May 2026 can’t be claimed against salary from 2027-28. They carry forward against future rental income or a capital gain. New builds keep negative gearing. Our 2027 changes playbook covers the detail. For a deeper look at how investment property deductions work, see our EOFY tax tips guide.
The inflation erosion argument
A $600,000 loan today will not feel like a $600,000 loan in 10 years. Inflation erodes the real value of debt.
Annual CPI inflation was 3.5% in July 2026 (ABS). If it held at 3.5% a year, $600,000 would be worth about $425,000 in today’s dollars after 10 years. You’re repaying today’s debt with tomorrow’s less valuable dollars. The property’s value and rental income both grow with inflation.
On an IO loan, you’re deliberately choosing not to pay down the principal during the growth phase of your investment. Instead, you’re letting inflation do the work. The loan balance stays at $600,000 in nominal terms. Its real value shrinks every year.
This is why paying down an investment loan early is generally not the priority for portfolio investors. Pay down your home loan (not deductible) first. Keep the investment loan balance high (deductible) for as long as it makes strategic sense.
When to switch to P&I
An IO period runs for a set term. Then the loan reverts to P&I. You can ask to extend it or roll into a new IO period. APRA expects the bank to run a fresh serviceability assessment before it agrees (APG 223).
Consider switching to P&I when:
- Your portfolio is mature and you’re no longer acquiring new properties. At that point, building equity through debt reduction becomes more valuable than cash flow flexibility.
- You’re approaching retirement and want to reduce your overall debt. The transition from accumulation to income phase means the strategy shifts.
- Interest rates drop significantly and P&I repayments become close to what IO was costing. When the gap narrows, the principal reduction becomes more attractive.
For investors who are still buying, IO can suit the first 5-10 years of each property. For a deeper look at how this fits into a portfolio scaling strategy, see our guide to building a property portfolio.
The IO rate premium in 2026
In July 2026, new interest-only investor loans averaged 6.50%, against 6.32% for new principal and interest investor loans (RBA table F6). That is a premium of 0.18 percentage points. The average variable rate across all new investor loans was 6.40%. At the large lenders it was about 6.3%.
The premium has narrowed since July 2019, the first month of the RBA series, when it was 0.37 points. At 0.18 points, the premium adds about $90 a month on a $600,000 loan. That is well below the $472 a month IO frees up in this example.
Your mortgage broker can compare IO and P&I rates across multiple lenders and structure the loan to maximise both cash flow and future flexibility. This is one of those areas where a broker who understands investment lending makes a material difference.
Don’t confuse IO with affordability
One important distinction: interest-only loans should never be how you stretch into a property you can’t afford. If you can’t comfortably service the P&I repayment on a property, the IO version only masks the cash flow problem. The bank assesses you on P&I anyway.
IO works best when you could afford P&I but choose IO for the cash flow, the deductions and a faster path to the next purchase. The property still has to stack up. If you want help finding properties where the numbers work in the first place, here’s what a buyers agent costs.
For a full picture of how investment property cash flow works, try our cash flow calculator.
This is general information only and not financial advice. Lending structures have significant tax and financial implications. Speak to your mortgage broker and accountant about how IO and P&I apply to your specific situation.
See how we find properties where the numbers work.
If you’re structuring a portfolio and want to understand how lending fits your strategy, book a free discovery call.
