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Understanding Interest-Only Home Loans

This article explains how an interest-only mortgage works in NZ.

Some borrowers in New Zealand want to free up funds for renovations or expand their portfolio and this structure can be useful to achieve this. An interest-only mortgage allows you to pay just the interest portion of your home loan for a set period – usually between 1 to 5 years. During this period, you are not reducing the principal loan balance. Some lenders now offer up to 10 years interest-only for investors

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How it Works

With a standard or typical mortgage, repayments are based on 2 components – principal plus interest. With an interest-only loan:

Monthly repayments are lower because you are paying only interest
Principal therefore remains unchanged
After the IO term ends, repayments increase as you start paying off principal

Illustrative simplified example of opting for Interest Only

The original amount of the loan was $500,000
Interest Rate: 4% per year
The loan is for 30 years, and the monthly principal and interest mortgage payment is $2,387

Let’s assume you choose IO for a period of 2 years. During this time, you only need to make interest payments, and the principal balance remains unchanged.

Calculation:

Monthly Interest Payment: $500,000 x 4% / 12 months = $1,667 in interest payments

Potential Savings: You can reduce your monthly mortgage payment from $2,387 (principal and interest) to $1,667 (interest only). This results in a monthly savings of $720 per month for the 2-year period.

Actual savings will vary based on individual mortgage terms, interest rates, and specific circumstances. It’s important to consult with a Mortgage Broker or Financial Adviser, to obtain accurate calculations, specific to your situation.

Who Can Apply for Interest-Only?

Property Investors – goal is to maximise rental returns and preserve capital
Self-employed borrowers – to manage cashflow in lean periods
Homeowners – free up capital for major expenses

Risks to consider:

Since there is no payment on principal, there is no equity being built during the IO term
Once IO period ends, payments increase sharply
May necessitate a refinance or restructure later

Bank vs Non Bank Lender Options

Mainstream banks typically offer 1-5 years. As of June 2025, some banks now offer 10-years for investors
2nd Tier lenders are more flexible and can offer 6 to 24 month terms and other options for borrowers who do not meet the banks criteria

Strategic Tip:

If you are using an IO loan to invest or renovate, have a longer term plan, which may include:

Selling the property at a much later date at a profit
Switching to principal and interest when your income increases or you come into large funds
Refinancing after the IO term ends to reset the loan term due to the longer term impact of IO. We’ll demonstrate.

Interest-Only Long Term impact:

It is important to think about how an interest only mortgage in NZ will affect the loan term as a whole.

Illustrative Simplified Calculation:

The loan was originally for 30 years, or 360 months.
Time period you only pay interest: 2 years (24 months).
After the Interest Only term expires, the repayment term gets reduced from 30 years to 28 years (336 months).
Before going on IO, your regular principal and interest repayments are $2,387 monthly.
Once on IO, your repayments for the next two years, would be $1,667 monthly.
After your term expires, your repayments will revert back to principal and interest. The new home loan payments will be recalculated. This will be done based on a 28-year term, opposed to the original 30-year term. Your new repayments going forward, would have increased to $2,476 monthly.

So, during the two-year term, the monthly payments are cut down to only the interest. This gives you immediate relief. However, once the interest only term expires, then your regular principal and interest repayments are increased to $2,476 monthly (because of the reduced period remaining on the loan, but principal was not paid)