One of the first decisions you'll make when financing an investment property is whether to go interest only or principal and interest. It's a question with real financial consequences, both in terms of your cash flow and your tax position. Here's a clear breakdown of both options so you can make an informed choice for your situation.

What's the Difference?

With a principal and interest (P&I) loan, your repayments cover both the interest charged and a portion of the loan balance. Your debt reduces with every payment, and you build equity in the property over time.

With an interest-only (IO) loan, your repayments cover only the interest. The loan balance stays the same throughout the interest-only period, which is typically up to five years (and sometimes up to ten years for investors with some lenders). At the end of the IO period, the loan rolls onto P&I repayments, which will be higher.

The Case for Interest-Only on an Investment Property

The primary argument for interest-only is cash flow. Lower repayments in the short term can free up capital to cover property expenses, maintain an emergency buffer, or service additional investments.

There's also a tax angle. All of your interest payments on an investment loan are tax-deductible. With a P&I loan, only the interest portion is deductible: the principal component is not. An interest-only loan maximises the deductible expense in the early years, which can be valuable for investors in higher tax brackets who are negatively gearing the property.

However, interest-only loans typically attract a slightly higher interest rate than P&I loans with the same lender. And over the full life of the loan, you'll pay more interest in total because the principal doesn't reduce during the IO period.

The Case for Principal and Interest on an Investment Property

P&I loans carry a lower interest rate in most cases, and you build equity in the investment property from the start. This can be advantageous if you plan to use that equity for further purchases down the track.

P&I also avoids the repayment shock that can occur when an interest-only period ends and repayments increase significantly. If your financial situation changes during the IO period, that step-up in repayments can be difficult to absorb.

What Regulators Say

APRA limits interest-only lending to 30% of new residential mortgages across the banking system. As a result, lenders apply stricter serviceability assessments for interest-only loans, which can reduce your borrowing capacity compared to a P&I application. It's worth knowing this before you commit to a strategy that assumes you'll get IO approval easily.

Which One Is Right for You?

There's no universal answer. The right choice depends on your tax situation, your cash flow position, how long you intend to hold the property, and your overall investment strategy.

For investors focused on maximising short-term cash flow and tax deductions while holding for long-term capital growth, interest-only can make sense. For investors who want to build equity faster or who prefer lower overall interest costs, P&I is worth considering. For some investors, a split approach works: P&I on the owner-occupied home (where interest is not deductible) and IO on the investment loan (where it is).

This is genuinely a discussion worth having with both a broker and a qualified tax adviser before you decide.

Get the Right Structure for Your Investment Loan

At Swish, we work with property investors to find the right loan structure from the start, not just the lowest rate. We compare interest-only and P&I options across our lender panel, factor in your tax situation, and give you a clear picture of the trade-offs before you commit.

Book a free call with Swish to discuss your investment loan structure.