Principal and Interest vs Interest-Only: What’s The Difference?

Explore the differences between principal and interest vs interest-only loans with Jacaranda Finance.
William Jolly  |  

Whether it's the structured journey of P&I loans or the initial flexibility of IO loans, we're here to guide you through the pros, cons, and key considerations of both, ensuring you make the choice that aligns best with your financial goals and lifestyle.

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What are principal and interest repayments?

Principal and interest (P&I for short) loans are the most common type of loan, especially when it comes to personal loans. When you take out this kind of loan, your repayments cover both the principal (the amount you borrowed) and the interest (the cost of borrowing the money).


Example:

Let’s say you borrowed $10,000 with a 15% interest rate for five years (no fees, fixed rate). Your principal amount here is $10,000, while the 15% will also be charged, adding to your repayments.

With principal and interest repayments, you would pay $238 per month and $14,274 in total throughout this loan.


What are interest-only repayments?

Interest-only loans (IO for short) are different. Initially, you only pay the interest that accumulates on your loan amount, not reducing the principal. After the conclusion of the IO period, the repayments will revert to P&I.

This type of loan is like paying the minimum on your credit card – it handles the immediate cost (interest) but doesn't reduce the actual debt (principal). As a result, your repayments at the conclusion of the interest-only period will be larger than the ongoing repayments on a principal and interest loan.


Example:

Let’s use the same example as above but for an interest-only period of two years. 

With principal and interest repayments, you would pay $238 per month and $14,274 in total throughout this loan.

But with a two-year IO period, your monthly repayments would initially be $125 before climbing steeply to $347 when reverting to P&I repayments. In total, this loan would cost $15,480 over five years - more than $1,000 extra compared to P&I repayments from the outset.

Use interest-only calculators such as MoneySmart’s to run your own calculations and see if an interest-only loan is right for you.


Is there such a thing as an interest-only personal loan?

In Australia, interest-only loans are primarily associated with mortgage lending rather than personal loans. Typically, personal loans in Australia are structured on a principal and interest basis.

Although there are some exceptions to this (see below), we’ll primarily discuss how interest-only loans apply to larger loans such as mortgages.

When might your personal loan repayments be interest-only?

There can be instances where a form of interest-only payment arrangement might apply to personal and car loans, particularly in cases of financial hardship. The lender may allow the borrower to pay only the interest component of the loan for a specified period. This reduces the repayment amount temporarily, providing some relief to the borrower during their financial hardship.

These measures are only temporary, though, and are meant to assist during short-term financial distress until the borrower can get back to repaying their total amount. They are not the same as a standard interest-only loan, which is a loan product where the interest-only period is a feature of the loan's structure from the outset.

See our article on financial hardship for more details on the kinds of relief measures that may apply.

Pros and cons of P&I vs IO loans

Both types of repayment have benefits and drawbacks. Below, we’ll discuss the pros and cons of each to help you decide.

Principal and interest loans: Pros and cons

Pros

  • A steady reduction in debt: By paying off the principal from the outset, each payment gets you closer to being debt-free.
  • Lower total cost: Typically, you pay less interest over the life of the loan.
  • Predictable repayments: Easy to budget long-term around consistent repayment amounts
  • Interest rates can be lower compared to IO loans.

Cons

  • Higher repayments: The repayments will be higher than the initial interest-only period on the same loan.
  • Short-term budgeting: This can be less effective for short-term budgeting and saving.

Interest-only loans: Pros and cons

Pros

  • Lower repayments initially: More manageable in the short term, freeing up cash for other expenses or investments.
  • Flexibility: Useful for short-term financial strategies, especially in property investments.
  • Hardship: This can also be a helpful strategy if you need a temporary reduction in repayments.

Cons

  • Higher overall cost: Eventually, you'll have to start paying off the principal, often leading to higher repayments later or a larger lump sum.
  • No reduction in principal: Your debt level remains unchanged during the interest-only period.
  • Not available for personal loans: Although there are exceptions, interest-only loans are usually only for more extensive, asset-based loans like mortgages.
  • Interest rates can be higher compared to P&I loans.

Principal & interest or interest-only: Which is right for you?

Whether you opt for the steady journey of principal and interest repayments or the initial ease of interest-only payments, the key is to align your choice with your financial situation and goals.

If it’s a personal or car loan you’re after, then you may not have much of a say in the matter at first. Most of these smaller consumer loans are principal & interest, although interest-only options may be available temporarily if you’re struggling to meet your repayments.

However, if you have the choice between the two (say, for example, if you’re buying a home), then there are genuine benefits to choosing either.

Property investors commonly use interest-only loans because they can afford various tax breaks. In Australia, the interest component of mortgage repayments is tax deductible for investment purposes, which means investors can often pay very little in the first few years of owning a property.

The lower repayments on IO loans can also be beneficial for those looking to break into the market. They can stretch their budget a little bit further and build up a savings buffer while still buying the home they want.

If you’re taking out an interest-only loan for any reason, make sure you’ve budgeted and prepared for your increased repayments when you revert to a P&I loan.

On the other hand, P&I loans could be an ideal choice for budget-conscious borrowers and those who want to pay less in interest overall over the life of the loan.


Other types of personal loans

There are a few more points of difference you should be aware of when choosing a personal loan. Two of the biggest are whether your loan:

  • Has a fixed interest rate or variable interest rate
  • Is secured or unsecured

Fixed vs variable personal loans

The two main types of interest rates on a personal or car loan are fixed and variable. 

A fixed-rate loan guarantees a fixed interest rate for a set period, known as the fixed term. On a personal loan, this is often the entire loan term, but only sometimes.

Variable interest rates, on the other hand, do not come with set rates for a period of time. Instead, they can fluctuate at the lender’s discretion based on a number of external and internal factors, meaning your repayments could change month-to-month.

At Jacaranda Finance, our loans come with fixed interest rates. See our article below on fixed vs variable-rate loans to learn more about each loan type, their pros and cons and which might be right for you.

Secured vs unsecured personal loans

When applying for a loan, you can also often choose between secured and unsecured loan options. Jacaranda offers both, depending on the circumstances.

A secured loan is a type of loan that requires security, also known as collateral, to be attached to the loan. This security is often something valuable like a car or vehicle and can result in larger loan amounts, lower rates and longer loan terms being available to the borrower.

Unsecured loans do not require any such security to be attached. While they can sometimes be easier and faster to get, they can be riskier to the lender and attract less favourable loan terms in your contract (like higher rates and fees) as a result.

Calculate your repayments with Jacaranda Finance

To see how much your principal and interest loan repayments might be with one of our loans, use our handy repayment estimate calculator below. If you like what you see, hit the button to get started!

Written by - William Jolly

Content Manager
William is the Content Manager at Jacaranda Finance. He has worked as both a journalist and a media advisor at some of Australia's biggest financial comparison sites such as Canstar, Compare the Market and Savings.com.au, and is passionate about helping Australians find the right money solution for them.

You can get in touch with William via williamj@jacarandafinance.com.au.
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