Interest-Only Home Loans: How They Work and Who They Suit

How it works

A standard home loan repayment has two parts: interest, and a slice of the amount you borrowed. With interest-only, you pay just the first part for an agreed period. When that ends, the loan reverts to principal and interest over whatever term remains.

On a $500,000 loan, the difference can be several hundred dollars a month. Run both through our mortgage calculator. And remember that after five interest-only years you still owe $500,000, with fewer years left to repay it.

What it costs

More, in two ways. You pay interest on the full balance for longer. And once the period ends, repayments are higher than they'd have been on a standard loan from the start, because the same debt is squeezed into a shorter time. Our guide to an interest-only period ending explains that jump.

Who lenders approve

• Property investors. The main users. Lenders commonly offer up to five years at a time on rentals.
• People building. Construction loans are interest-only during the build as standard.
• Bridging between homes. Short-term, until the old house sells.
• Owner-occupiers with a specific reason. Parental leave, a temporary drop in income, a renovation. Usually six to twelve months, and lenders want to hear the reason.

In every case the lender tests whether you could afford principal-and-interest repayments over the remaining term. Interest-only doesn't let you borrow more. If anything it makes the test harder.

When it makes sense

Investors with a home loan as well. Interest on a rental loan is generally tax-deductible and interest on your own home isn't. Paying interest-only on the rental and putting every spare dollar onto your own mortgage clears the non-deductible debt first. That's a common structure. Confirm the tax side with your accountant.A short squeeze. A year of parental leave, or the first year of a business. Lower payments for a defined period, with a plan for afterwards.Cash needed for something that pays better. A renovation that adds value before a sale, for example.

When it doesn't

As a way to afford a house you couldn't otherwise afford. If the loan only works on interest-only, the house is too expensive, and the end of the period will prove it.

It's also a poor choice if you're counting on prices rising to build your equity. They may. They may not, and then you've spent five years paying for a debt that hasn't moved.

Alternatives worth a look

• Extending the loan term lowers repayments while still reducing the debt a little.
• An offset and revolving credit facility lets savings cut your interest without giving up flexibility.
• Interest-only on one split, not the whole loan.

This article explains how New Zealand lenders generally assess these situations. It is general information, not personalised financial advice, and lender policy changes often — check your own position with a registered adviser. Official sources: Reserve Bank of New Zealand for lending policy and the OCR, and Sorted.org.nz for independent government-backed money guidance.