Interest-Only or Principal and Interest? What Investment Property Buyers Should Know
Property investors buying with finance are often steered towards interest-only (I/O) repayments rather than principal and interest (P&I). If you’re not familiar with Australian lending, that can sound like paying more overall, but that’s not quite right once an offset account is in the picture. The combination gives you more flexibility than a standard P&I loan, and, for many investors, works out better. We still find plenty of clients aren’t clear on how an offset account actually works, and the ongoing account-keeping fee (typically in the low hundreds of dollars a year) puts some people off before they’ve worked out whether it’s worth it. Here’s how offset accounts and I/O repayments fit together.
What is an offset account?
An offset account is simply an everyday transaction account linked to your home loan account. Say you borrow $500,000: your loan account starts at a $500,000 balance. Open (or link) a linked transaction account, and any balance sitting in it “offsets” the loan balance for interest calculation purposes, so $100,000 sitting in the offset account means you only pay interest as if you owed $400,000. Some lenders bundle the offset account in automatically with the loan; others require you to open it separately. You use the offset account like any normal transaction account, paying your salary into it and spending from it day to day, while its balance continuously reduces the interest charged on your loan.
Key features
- Interest is calculated daily, since your offset balance can change day to day
- Offset accounts are typically bundled as part of a lender’s package product
- Usually only available on variable-rate loans, though some lenders offer limited offset functionality on fixed rates too
Why an offset account helps
1. It saves interest
This is the headline benefit. If you owe $500,000 and hold $250,000 in your offset account, you only pay interest on $250,000; hold the full $500,000 offset and you’d pay no interest at all, though your repayments don’t stop. Say your repayment is $2,000 a month with no offset balance: part of that is interest, part is principal. With a $500,000 offset balance, you’d still pay the same $2,000, but now all of it reduces the principal, since there’s no interest component, which pays the loan down faster. You could even direct your salary straight into the offset account to maximise the effect. It’s a better place for spare cash than a standard savings account, since even a modest savings rate is almost always lower than your home loan rate, so offsetting reduces the higher-rate debt rather than earning the lower-rate return.
2. It’s flexible
Because it’s your own transaction account, you can withdraw from it freely whenever you need the funds, and top it back up when you have a surplus. Interest offset adjusts from the day money moves in or out.
3. There’s a potential tax angle
For an investment property loan, interest on the loan balance is generally deductible. If you paid extra directly into the loan instead of using an offset, you’d permanently reduce the loan balance and, with it, your future deductible interest. Money held in an offset account instead doesn’t reduce your deductible interest at all (the loan balance and the interest it generates stay intact) while also cutting the actual interest you pay. And because offset balances aren’t a separate interest-bearing account, the funds sitting there don’t generate assessable interest income the way a standard savings account would.
Putting I/O and offset together in practice
A common structure: pay interest-only for the first five years, direct any spare cash into the offset account rather than making extra principal repayments, and keep that flexibility to draw on the funds if needed. At the end of the five-year I/O period, some borrowers refinance and reset to another interest-only term, though lenders reassess borrowing capacity as you age, and older borrowers are often limited to shorter loan terms (commonly 15 to 25 years for borrowers around 60 and above).
In short: offset accounts are usually limited to variable-rate loans and come with an ongoing fee, but combined with interest-only repayments on an investment property, they can meaningfully reduce interest paid while keeping your cash flexible. If you’d like to talk through whether this structure suits your situation, get in touch. We’re happy to help.
