Interest Only Loans? Discover the Hidden Costs (2026)

As you're exploring your mortgage options, you might find interest only loans intriguing, especially if you're trying to manage cash flow. However, you're likely wondering, do interest only loans have higher rates? Understanding the nuances of these loans can help you make an informed decision, ensuring you pick the right product for your financial situation.

Understanding Interest Only Loans

Interest only loans are a type of mortgage where, for a specified period, you only pay the interest on the amount borrowed. Typically, this period lasts between one to five years. After this period, the loan reverts to a principal and interest loan, meaning you'll start paying down the amount borrowed along with the interest.

These loans are particularly popular among investors who might be looking to maximise their cash flow or among borrowers who anticipate a significant increase in their income in the future. However, it's crucial to understand that while you're not paying down the principal, your debt remains the same, and the overall interest paid over the life of the loan can be more substantial.

Interest Rates and Requirements

In 2026, the Australian mortgage market continues to show a trend where interest only loans often carry higher interest rates compared to their principal and interest counterparts. This is primarily due to the increased risk perceived by lenders, as the principal amount remains unchanged during the interest only period.

The current interest rates for interest only loans typically range from 6.49% to 8.5%, depending on the lender and the borrower's financial profile. In comparison, principal and interest loans are usually offered at rates between 5.5% to 7.0%.

Lenders typically require a higher deposit for interest only loans, often around 20% of the property value, compared to as little as 5-10% for principal and interest loans. Additionally, lenders assess your ability to repay the full loan amount once the interest only period ends, which means they may scrutinise your income and expenses more closely.

How to Secure an Interest Only Loan

Securing an interest only loan involves several steps, and understanding these can ensure a smoother application process:

1. Assess Your Financial Situation: Determine if you can comfortably afford the higher repayments after the interest only period ends.
2. Compare Lenders: Use Esteb and Co's access to 83+ lenders to find competitive rates and terms that suit your needs.
3. Prepare Documentation: Gather proof of income, expenses, credit history, and other relevant financial documents.
4. Submit Your Application: Apply with the lender offering the best terms, ensuring all information is accurate and complete.
5. Consult with Experts: Work with a mortgage broker from Esteb and Co to navigate complex terms and ensure you're getting the best deal.

Expert Tips and Considerations

When considering an interest only loan, it's important to weigh the benefits against potential drawbacks:

• Plan for the Future: Ensure you have a strategy for managing higher repayments once the loan transitions to principal and interest.
• Consider Your Investment Strategy: If you're an investor, an interest only loan might help maximise cash flow, but ensure it aligns with your long-term financial goals.
• Monitor Market Conditions: Interest rates can fluctuate, impacting your overall loan cost. Stay informed about market trends and consider refinancing if beneficial.
• Seek Professional Advice: A mortgage broker can provide tailored advice, especially with access to a wide range of products like those offered by Esteb and Co's extensive lender panel.

Frequently Asked Questions

1. Do interest only loans have higher rates than principal and interest loans? Yes, typically, interest only loans have higher rates due to the perceived risk by lenders.
2. How long does the interest only period last? The interest only period usually lasts between one to five years.
3. Can I switch from an interest only loan to a principal and interest loan? Yes, most lenders allow you to switch, but it's essential to check for any fees or conditions.
4. What happens after the interest only period ends? Your loan will revert to a principal and interest repayment, meaning your monthly repayments will increase.
5. Are interest only loans suitable for first-time homebuyers? They can be, but it's crucial to assess your long-term ability to meet higher repayments.
6. How do lenders assess eligibility for interest only loans? Lenders evaluate your income, expenses, and overall financial situation, focusing on your ability to repay the loan after the interest only period.
7. Is refinancing an interest only loan possible? Yes, refinancing is possible and can be beneficial if interest rates have decreased or if you need to adjust your repayment terms.