Quick Answer
Interest-only loans require only the interest to be repaid each period; the principal stays unchanged. Principal and interest (P&I) loans repay both components, reducing the loan balance over time. Interest-only lowers monthly repayments (improving cash flow) and maximises tax-deductible interest; P&I builds equity faster and carries less refix risk. NZ banks typically allow interest-only for up to 5 years on investment properties. Interest-only suits high-growth strategies where cash flow is prioritised early; P&I suits long-term wealth building.
What’s the Difference?
Every mortgage repayment has two components: interest (the lender’s fee for lending the money) and principal (paying down the amount you borrowed). The structure you choose determines how those two components are split.
With a principal and interest (P&I) loan, each repayment covers both. Your balance reduces every month. With an interest-only (IO) loan, you pay only the interest — the principal stays exactly the same until the IO period ends and the loan reverts to P&I.
IO suits investors prioritising cash flow, tax efficiency, and short-to-medium holds. P&I suits owner-occupiers, long-term holders, and anyone who wants to build equity steadily and minimise total interest paid. Most experienced investors use a mix across their portfolio depending on the property’s role.
How Repayments Compare
Using a $600,000 loan at 6.5% interest over 30 years, here is how the two structures compare in year one and at the IO rollover point.
When the IO period expires, the loan automatically reverts to P&I. Because no principal was paid down, the full $600,000 must now be repaid over only 25 years instead of 30 — a shorter term that increases the required repayment significantly.
The reversion takes the repayment $801 above where it would have been on a standard P&I loan. Investors who stretched to afford the IO payment can find themselves in difficulty when the reversion hits.
Why Investors Choose Interest-Only
For many NZ property investors, interest-only is the default structure for investment lending. The reasons are practical rather than accidental.
Lower monthly outgoings
- IO keeps monthly costs low, leaving more cash in hand each month.
- On a property returning $2,800/month rent, a $543 lower repayment can turn a cash-flow-negative deal into a cash-flow-neutral or positive one.
- Better cash flow makes a portfolio easier to hold through rate rises, vacancies, and maintenance surprises.
Maximum deductible expense
- On IO, every dollar of your repayment is interest — and interest is a fully deductible expense against rental income.
- On P&I, the principal portion is not deductible. As you pay down the loan, your annual interest expense shrinks and your tax bill grows.
- For investors in high tax brackets, maintaining maximum interest expense is a deliberate strategy to minimise taxable rental income.
Redeploy equity into more assets
- If you are planning to sell within 5–7 years, there is little value in paying down a loan you will repay at settlement anyway.
- Redirecting the principal portion of a P&I payment into a savings account or offset lets you deploy that capital more flexibly.
- Investors growing a portfolio sometimes use IO on existing properties to preserve cash for deposits on the next acquisition.
Voluntary lump-sum payments
- IO loans often allow unlimited lump-sum payments without penalty. You can pay down principal voluntarily when cash is available, rather than being locked into a mandatory monthly amount.
- This suits investors with variable income (self-employed, seasonal) who prefer lower baseline commitments with flexibility to pay extra in good months.
Why P&I Builds Long-Term Wealth
Interest-only defers the work of paying down debt. P&I does it relentlessly and cheaply, through the power of amortisation. For many long-term investors, the discipline and certainty of P&I outweighs its higher monthly cost.
-
You pay ~$45,000 less in total interest. Because P&I reduces your balance every month, the interest component of each payment shrinks over time. Compounded over 30 years, this adds up to tens of thousands less paid to the bank.
-
You build equity through repayments, not just capital growth. After 5 years of P&I, you owe roughly $39,000 less than when you started. That equity is real, accessible, and does not depend on prices rising.
-
Repayments are predictable forever. The P&I repayment never changes (on a fixed-rate portion) and never jumps. There is no reversion shock to plan for. This predictability has real value for long-term planning.
-
A lower LVR improves your financial position over time. As P&I reduces your loan balance, your LVR falls. A lower LVR can qualify you for better interest rates, removes low equity margins, and gives you more security against a market downturn.
-
Owner-occupiers almost always use P&I. Since owner-occupier mortgage interest is not tax-deductible, there is no tax incentive to maintain a large interest expense. P&I is the standard and almost always the right structure for your own home.
RBNZ Rules on Interest-Only Lending
The RBNZ sets guidelines on how much IO lending banks can carry on their books. These are not hard prohibitions — they are portfolio concentration limits that banks manage internally — but they translate into practical restrictions for borrowers.
The serviceability test is worth understanding. When you apply for an IO loan, the bank does not test whether you can afford the IO repayment — it tests whether you could afford the full P&I repayment. This prevents borrowers from overextending on the assumption that IO will continue indefinitely.
Many investors assume they can simply roll their IO term over every 5 years indefinitely. Banks are not obligated to approve this. At renewal, they reassess your income, the property’s rental income, your total debt, and the current lending environment. If conditions have tightened or your situation has changed, a renewal could be declined — forcing an unplanned switch to P&I and a significant repayment increase.
Interest Deductibility — The NZ Context
The interaction between loan structure and tax deductibility is uniquely important in New Zealand, where the rules on interest deductibility for investors changed significantly in 2021 and have since been reversed.
Residential rental property interest was 100% deductible against rental income, the same as other business expenses. IO was the preferred structure for most investors precisely because it maximised deductible interest.
The Labour government removed interest deductibility for residential rental properties (excluding new builds) in a phased process. By the 2023/24 year, most investors could deduct only 50% of interest. This significantly changed the IO vs P&I calculation — maximising interest expense was less valuable if only half was deductible.
The National-led government reversed the policy. From 1 April 2024, 80% of residential rental property interest became deductible again for existing investment properties. New builds retained 100% deductibility throughout the entire period.
From 1 April 2025, 100% of residential rental property interest is once again fully deductible for most investment properties. The pre-2021 tax treatment has been reinstated. This restores the full strategic value of IO for investors who want to maximise their deductible interest expense.
In year one the difference is small because P&I hasn’t paid down much principal yet. But by year 10, the gap is larger — a P&I borrower has paid down roughly $75,000 of principal and is paying noticeably less interest each year. The IO borrower still has the full $600,000 outstanding and $39,000 of annual deductible interest.
Which Structure Suits Your Strategy?
There is no universal answer. The right choice depends on your cash flow position, investment timeline, tax situation, and how you plan to use the equity in your properties.
- Cash flow is tight. The property is marginally cash-flow negative and the $400–$600/month saving makes it viable to hold.
- You plan to sell within 5–10 years. Capital growth, not debt reduction, is driving your return. Paying down principal adds little value if you are selling anyway.
- You are actively growing a portfolio. Preserving cash flow and flexibility allows you to save for your next deposit faster.
- You are in a high tax bracket. Maximising deductible interest reduces your taxable rental income meaningfully at 33% or 39%.
- You have other high-cost debt. If you have personal debt at higher rates, directing that $500/month to paying it off first makes financial sense.
- This is your home. Interest is not deductible on owner-occupied property. There is no tax reason to maintain a large IO balance.
- You are a long-term buy-and-hold investor. Over 20–30 years the ~$45,000 interest saving from P&I compounds into meaningful wealth.
- The property is strongly cash-flow positive. If rent covers P&I with cash left over, there is no cash flow reason to use IO.
- You want certainty. No reversion shock, no renewal negotiation. The same payment every month for 30 years is simpler to plan around.
- You are nearing retirement. Reducing debt before retirement lowers your required income and risk exposure.
Common Mistakes to Avoid
-
Assuming IO renewal is automatic. Banks reassess at renewal. If interest rates have risen significantly or your financial position has changed, the bank may require you to move to P&I. Plan for this possibility rather than budgeting on IO continuing indefinitely.
-
Using IO on your home. Mortgage interest on owner-occupied property is not deductible in NZ. There is no tax benefit to IO on your own home — only a higher total interest cost and a static loan balance that never reduces.
-
Ignoring the reversion shock in serviceability planning. Structuring your finances around the IO repayment, with no buffer for when it ends, is a common trap. Model your budgets at the post-reversion P&I rate from day one.
-
Spending the IO saving rather than deploying it. If you choose IO to free up $500/month, have a clear plan for that money — building a maintenance reserve, paying down non-deductible debt, or saving for your next deposit. Without a plan, the cash flow advantage evaporates into lifestyle spending.
-
Not accounting for deductibility changes. The past decade showed that interest deductibility can be removed and restored by government policy. Build scenarios that account for partial or zero deductibility, so you are not caught out if the rules change again.
-
Treating IO as a long-term buy-and-hold strategy without a plan for debt reduction. At some point, debt must be repaid. IO is a tool for managing cash flow in the growth phase of a portfolio. Investors who never transition to P&I can reach retirement carrying the same debt they started with.
Model the numbers on your own investment
Use our free calculators to compare loan structures, estimate your yield, and plan your mortgage strategy.