Interest Only Loans? Discover Tax Benefits (2026)

For many Australians, understanding the tax implications of different loan types can be a daunting task. If you're considering an interest-only loan, you might be wondering if the interest paid on such loans is tax deductible. This is a crucial question, especially for property investors looking to maximise their tax benefits. In this comprehensive guide, we'll delve into the specifics of interest-only loans and their tax implications, providing you with the knowledge you need to make informed financial decisions.

Understanding Interest Only Loans

Interest-only loans are a type of mortgage where, for a set period, you only pay the interest on the loan balance. This means your monthly repayments are lower than a principal and interest loan during the interest-only period. However, you will not reduce the principal amount of the loan during this time. Typically, an interest-only loan period lasts between 1 to 5 years, after which you will need to start repaying the principal, or refinance the loan.

Interest Rates, Requirements, and Options

In 2026, interest-only loans typically have interest rates ranging from 6.49% to 8.29%, which can be slightly higher than the rates for principal and interest loans. Borrowers must meet specific criteria to qualify for an interest-only mortgage. Lenders often require a higher credit score and a lower loan-to-value ratio compared to standard loans. The borrower's ability to switch to principal and interest repayments after the interest-only period is also a key consideration.

Loan Type	Interest Rate Range	Key Features
Interest Only	6.49% - 8.29%	Lower initial repayments, no principal reduction
Principal and Interest	5.99% - 7.49%	Higher initial repayments, reduces principal

How to Determine Tax Deductibility of Interest Only Loans

To determine whether the interest on your loan is tax deductible, you need to consider the purpose of the loan. Generally, if the loan is used for investment purposes, such as purchasing a rental property, the interest is tax deductible. However, if the loan is for personal use, like buying a home to live in, the interest is not deductible. Here's a step-by-step guide to help you:

1. Identify the purpose of the loan. Ensure it is for income-producing activities.
2. Keep thorough records of how the loan funds are used.
3. Consult with a tax professional to confirm deductibility based on your specific situation.
4. Claim the deductible interest in your tax return under the appropriate section.

Tips and Considerations

When considering an interest-only loan, it's important to weigh the potential tax benefits against the long-term financial implications. Here are some expert tips:

• Consider your long-term financial goals and how an interest-only loan fits into them.
• Evaluate your financial capacity to handle increased repayments after the interest-only period ends.
• Utilise the expertise of mortgage brokers, like those at Esteb and Co, who have access to over 83 lenders, to find a loan that best suits your needs.
• Regularly review your financial strategy and adjust as necessary to meet changing market conditions.

Frequently Asked Questions

1. Is the interest on an owner-occupied home loan tax deductible?
   No, interest on a loan for a home you live in is not tax deductible.
2. Can I switch from an interest-only to a principal and interest loan?
   Yes, most lenders allow you to switch, but it's best to check the terms with your lender or broker.
3. How long can I have an interest-only loan?
   Interest-only periods typically last from 1 to 5 years, but it varies by lender.
4. Are there risks associated with interest-only loans?
   Yes, the primary risk is that you won't build equity during the interest-only period, potentially impacting your ability to refinance or sell.
5. What happens after the interest-only period ends?
   Your repayments will increase as you begin to repay the principal along with interest, unless you refinance.
6. Do interest-only loans have higher interest rates?
   They often have slightly higher rates compared to principal and interest loans.