Interest-only maximises your deductible interest and your cash flow risk at the same time. Principal-and-interest reduces the debt and your tax deduction together. The right answer depends on what the debt is doing for you — not on what the lender defaults to.
What each structure does
With an interest-only (IO) loan, every repayment is interest — fully deductible while the property is rented, and the loan balance does not move. With principal-and-interest (P&I), part of each payment reduces the loan, and that part is not deductible.
That one difference drives three others: cash flow, tax position and refinance risk.
The cash flow difference
A P&I repayment is always larger than an IO repayment at the same rate. On a $720,000 loan at 6.25% over 30 years, the IO repayment is roughly $3,750 a month; the P&I repayment is roughly $4,434 a month — about $684 a month (or $158 a week) more. That extra amount is not deductible and does not lower your taxable income. It builds equity and shrinks the interest bill over time, but it is cash out of your pocket every month.
The tax difference
Interest-only keeps the full loan balance — and therefore the full interest bill — deductible. As you pay down a P&I loan, the interest component falls, so the rental loss (and its tax effect) shrinks year after year. The trade is explicit: paying down debt costs cash now and lowers future tax relief; interest-only keeps the relief but leaves the debt standing.
The risk difference
- Refinance risk. IO loans convert to P&I at the end of the interest-only period, and the repayment jumps. If the property is neutrally geared on IO, the jump to P&I can turn it into a significant cash drain.
- Interest rate risk. IO periods are usually 1–5 years, so the rate is reset more often.
- Equity risk. P&I builds equity that can be redeployed or used as security, and it reduces the outstanding principal that future rate rises act on.
A worked example
| Interest-only | P&I (30 yr) | |
| Loan | $720,000 | $720,000 |
| Rate | 6.25% | 6.25% |
| Annual interest paid | $45,000 | $44,300 (year 1) |
| Principal repaid (year 1) | $0 | $8,200 |
| Weekly repayment | $865 | $1,023 |
| Principal repaid at 5 years | $0 | ≈ $44,000 |
Illustrative. Rates and terms change the exact figures; the structure of the trade does not.
An interest-only structure is not "cleverer". It is a decision to keep debt high for a tax and cash-flow reason. Model it against P&I before you choose — the calculator lets you switch loan type and see the weekly difference.