Definition
An interest-only loan, or interest-only period, is one where repayments cover only the interest charged and do not reduce the principal. Repayments are lower than on a principal-and-interest loan of the same size, but the full balance is still owed at the end. Interest-only terms are common on bridging, caveat and some commercial property loans, where repayment comes from a sale or refinance.
Interest-only repayments are a cash flow tool. They free up money in the short term at the price of leaving the debt untouched.
Where they are used
Short-term property-secured finance, such as bridging loans and caveat loans, often runs interest-only because the balance is meant to be cleared by a sale or new loan a few months later. Some commercial property loans offer an initial interest-only period while a business settles into new premises.
The planning question
Because the principal is still owed in full, the most important part of an interest-only loan is the exit. Before signing, write down how and when the balance will be repaid and what happens if that takes longer. For a worked approach, read planning the exit from a short-term loan.
Compare total cost
Compare the total cost of interest-only and principal-and-interest options over the same period, including any capitalised interest. ASIC Moneysmart explains loan basics.
To see whether an interest-only structure fits your plan, make one enquiry.
Common questions
Is interest-only cheaper?
Each repayment is lower, but because the principal does not fall, total interest over the same term is usually higher.
What happens when the interest-only period ends?
The loan either switches to principal-and-interest repayments, which are higher, or must be repaid in full or refinanced.
Can interest be capitalised instead?
Some short-term loans add interest to the balance rather than charging it monthly. That increases the amount owed at the end.
Sources and further reading
Related terms