The three reasons investors choose IO come down to cash flow, tax deductions, and capital allocation. On an investment property, all interest is generally tax deductible - so keeping the debt higher and the interest portion of repayments maximised can reduce your taxable income. Lower monthly repayments also free up cash that can be redirected toward additional investments, renovations, or a personal loan buffer.
It is important to understand that IO does not save you money over the life of the loan - it defers principal repayment. The tax benefit can make the net cost lower in the short term, but the total interest paid over 30 years on an IO loan is higher than on an equivalent P&I loan. Speak with your accountant about your specific tax position before deciding.
During the interest only period your balance does not decrease. If you borrow $600,000 and make IO repayments for 5 years, you still owe $600,000 at the end of year 5. The loan then reverts to principal and interest, but you now have only 25 years remaining to pay off the full $600,000 (assuming a 30-year loan). This means your P&I repayments when you revert are higher than they would have been if you had started on P&I from day one.
Some lenders allow you to reset the loan term at the end of the IO period, effectively extending back to 30 years, but this is not automatic and requires an application. Lenders also reassess serviceability at that point under current policy, which may differ from when you originally borrowed.
The three key risks are no equity building, repayment shock at revert, and LVR creep. Because you are not paying down the principal, your equity only grows through capital gains in the property value. In a flat or falling market, you may have no more equity at the end of a 5-year IO period than when you started.
Repayment shock is real. The jump from IO to P&I repayments on a large loan can be several hundred dollars per month. Investors who have not budgeted for this - or whose circumstances have changed - can find the revert period difficult. LVR creep is the related risk: if the property value falls while you are on IO, your LVR rises, potentially locking you out of refinancing options.
IO tends to make sense for investors with strong cash flow who are in a higher tax bracket, who have a clear strategy for the IO period (such as using the freed cash flow to pay down their owner-occupied mortgage faster), and who are buying in a growth corridor where capital appreciation is likely.
P&I on an investment loan makes sense when the tax benefit is modest, when you want the security of building equity, when rates are competitive on P&I products, or when you are approaching retirement and want to reduce debt. There is no universal answer - a broker who understands your full financial picture can model both scenarios against your actual numbers.
Jason and Steve are Adelaide mortgage brokers who give honest, practical advice at no cost to you. No obligation.
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