When interest-only ends: the repayment step-up

What actually happens at expiry

On the day the interest-only period ends, the loan converts to principal and interest over the term that is left, not the term you started with. A 30-year loan with a five-year interest-only period does not amortise over 30 years; it amortises over 25, because the first five years repaid nothing. The whole original principal now has to be cleared in a shorter window.

That is the mechanism behind the step-up, and it is why the jump is bigger than people expect even when the interest rate is unchanged or lower. Borrowers reason that they are simply "adding principal" to their existing repayment. In fact they are adding principal and compressing the schedule at the same time, and the compression is doing most of the work.

The conversion is automatic. Nothing needs to go wrong for it to happen, no lender has to make a decision, and the only notice most borrowers get is a letter that arrives in the same envelope pile as everything else. The obligation changes on schedule whether the household budget is ready or not.

The step-up in dollars

Take a $700,000 loan at 6.5 per cent on a 30-year term with a five-year interest-only period. During the interest-only years the repayment is $700,000 multiplied by 6.5 per cent, divided by twelve — about $3,792 a month, and none of it reduces the balance. At expiry, the same $700,000 has to be repaid with interest over the remaining 300 months, which is about $4,727 a month.

That is an increase of roughly $935 a month, or close to $11,200 a year, on a rate that has not moved. Across typical loan sizes and interest-only terms the step-up generally lands somewhere between 20 and 40 per cent, with longer interest-only periods producing bigger jumps because the amortisation window is shorter when it finally starts.

The comparison that clarifies the cost is against a borrower who took principal and interest from day one. On the same $700,000 at 6.5 per cent over 30 years, that borrower pays about $4,424 a month from the start. After the interest-only period the first borrower is paying roughly $300 a month more than that, and keeps paying it for the next 25 years. Interest-only did not defer the cost; it moved it and enlarged it.

The total interest nobody quotes you

Over the full life of that loan, the interest-only path costs roughly $53,000 more in interest than the straight principal and interest path, because the balance sat at $700,000 for five years instead of falling. Interest is charged on the balance, and the balance is the whole point.

Investment interest-only loans usually carry a rate premium as well, commonly in the range of 0.20 to 0.50 percentage points above the equivalent principal and interest rate depending on the lender and the loan-to-value ratio. Add that to the structural cost and the gap widens further. This does not make interest-only wrong — there are cash flow and tax reasons investors choose it deliberately — but it should be chosen with the number in front of you rather than because it was the default on the application.

Extending interest-only is harder than getting it was

An extension is a new credit decision, not an administrative request. The lender reassesses income, expenses and liabilities on current policy, orders a valuation in most cases, and applies the serviceability test in force at the time. With the cash rate at 4.35 per cent after three increases during 2026 and APRA’s 3 percentage point buffer reconfirmed in May 2026, that test is tougher than the one you passed when the loan was written.

There is a structural reason it is harder still. Regulatory guidance requires lenders to assess an interest-only loan on the principal and interest repayment over the remaining term, not the interest-only repayment being made. So a borrower asking to extend a five-year interest-only period on a 30-year loan is assessed on a 25-year amortising repayment — the very repayment they are trying to avoid. Passing the extension test means demonstrating you could afford not to extend.

Lenders also want a reason and an exit. "Cash flow is tight" is the answer least likely to succeed, because it describes the risk the policy exists to manage. A documented investment strategy, a construction or renovation period, a temporary income interruption with a return date, or an imminent sale are all more workable, and total interest-only exposure across a portfolio is separately capped by most lenders.

Interest-only in a falling market builds no buffer

The unstated assumption behind long interest-only terms is that the property appreciates while the balance stays flat, so equity accumulates without repayments. That assumption is not currently holding. National dwelling values fell 0.9 per cent in August 2026, a fifth consecutive monthly decline, and sit 3.6 per cent below the March 2026 peak.

For an interest-only borrower that combination is unhelpful in a specific way: the balance has not moved down and the valuation has moved down, so the loan-to-value ratio rises without anyone doing anything. A high-LVR purchase from 2025 on interest-only can therefore be closer to its lender’s policy ceiling now than it was at settlement, which constrains exactly the things you would want available — an extension, a refinance, a top-up, or a release of a guarantee.

This is also the mechanism behind refinance refusals at interest-only expiry. Borrowers assume they can move lenders if their own lender declines an extension, but a refinance is assessed on the current valuation and current serviceability, and both have moved in the wrong direction for many recent high-LVR loans.

What to do twelve months out

Find the expiry date. It is in the loan schedule or in internet banking, and a surprising number of borrowers do not know it. Then calculate the actual reverting repayment — principal and interest over the remaining term at a realistic rate, not the current interest-only figure plus a guess — and put that number in the household budget for a few months to see whether it works.

From there the options are: do nothing and absorb the step-up, which is the right answer more often than it sounds; ask your lender to reprice the loan, since the interest-only premium falls away on conversion and a repricing request costs nothing; refinance, if serviceability and the current valuation allow; convert part of the balance and leave part interest-only, which is a way to phase the increase; extend the interest-only period if you can pass the harder test; or extend the loan term, which lowers the monthly repayment by lengthening the amortisation but increases total interest and is subject to lender age and exit-strategy policy.

Start twelve months out rather than one, because several of those options need a valuation, a formal application and time to organise documents. A borrower with a year of runway has six choices. A borrower with three weeks has one.

Investors: the deduction behind the strategy is changing

Interest on an investment loan is deductible and principal is not, which is the tax logic many investors use to justify interest-only. That logic is being altered by law already passed. From 1 July 2027, net rental losses on established residential property acquired after 7:30pm AEST on 12 May 2026 are quarantined — carried forward against future rental income or capital gains rather than deducted against salary — with property held or under contract at that moment grandfathered, and new builds outside the restriction.

For an affected investor the interest is still an expense but the refund that used to arrive in the same financial year does not, which changes the cash flow arithmetic that made a high interest-only balance comfortable. Anyone planning an interest-only extension partly for tax reasons should be running that plan past a registered tax agent against the post-2027 rules rather than the pre-2026 ones.

Azure Home Loans can model the reverting repayment, test whether an extension or refinance is realistic on current policy, and put a repricing request in before the conversion date. The figures on this page are worked illustrations at an assumed rate for Australian readers as at September 2026, not a quote, an approval or tax advice; your own rate, remaining term and lender policy determine the actual outcome.