Quick answer
Interest-only means your regular repayments cover only the interest charged on the loan, so the balance you owe doesn't fall. It keeps payments lower for a set period, often one to five years on commercial property loans, or for the whole term on short bridging, caveat and construction loans. When the period ends, you either repay the principal in a lump sum or switch to principal and interest.
Key points
- Repayments cover interest only; the loan balance stays where it started
- Common on commercial property, bridging, construction and caveat loans
- When the interest-only period ends, the principal must be repaid over fewer years, so repayments rise
- Total interest is higher because the full balance is owed for longer
With an interest-only loan, you pay the cost of borrowing but not the borrowing itself. Each repayment covers the interest charged for that period and nothing more, so after a year of payments you still owe exactly what you borrowed.
Where interest-only shows up in business lending
Interest-only is a tool for specific jobs rather than a default setting.
- Commercial property loans: an initial interest-only period, often a few years, keeps repayments lighter while a new purchase beds in or a tenant settles.
- Bridging finance and caveat loans: these short loans are normally interest-only throughout, because the plan is to repay everything from a sale or refinance.
- Construction and development finance: a project earns nothing until it’s finished, so interest is paid as you go or capitalised until completion.
- Lines of credit and overdrafts: you typically only have to cover interest on what you’ve drawn, with no set principal reduction.
Some short-term lenders collect interest upfront as prepaid interest, deducted from the advance. That’s a related but different arrangement: you receive less cash on day one and have no interest payments during the term.
The repayment jump nobody models
The interest-only period doesn’t remove principal from the loan; it postpones it. When the period ends, the same principal has to be repaid over fewer years, so the principal part of each repayment is bigger than it would have been from the start.
You can see this without any interest figures at all. Take an $800k commercial property loan over 25 years:
| Principal and interest from day one | Five years interest-only, then P&I | |
|---|---|---|
| Years to repay $800k | 25 | 20 |
| Average principal repaid per year | $32k | $40k |
| Increase in principal per year | — | 25% higher |
| Balance after year five | Lower | Still $800k |
On top of that, interest is charged on the full $800k for those first five years rather than on a falling balance, so total interest over the loan is higher. Our business loan repayment calculator lets you test the before-and-after numbers.
If an interest-only period is about to roll off and the new figure looks heavy, talk to us about your options before the first higher payment falls due.
Why regulators have watched it closely
Interest-only lending has drawn scrutiny in Australia. In 2015 ASIC reviewed interest-only home loans at 11 lenders and pushed them to check whether borrowers could manage the higher repayments once the period ended. In March 2017 APRA asked banks to keep interest-only loans to around 30% of new residential mortgage lending, a temporary limit it removed from 1 January 2019.
Those rules targeted home loans, not business finance, but the lesson carries over. Lenders assessing a business loan with an interest-only period will usually check that you can afford the principal and interest repayments too, which is part of their serviceability test.
When it makes sense, and when it doesn’t
It suits borrowers with a clear exit strategy: a property sale, a project finishing, a refinance, or a business that needs breathing room for a defined period and will be stronger at the end of it. It suits less well when it simply hides a repayment you can’t afford. The bill doesn’t shrink; it just arrives later.
Related terms
Principal and interest, principal, loan term, bridging loan and refinance.
Planning a loan with an interest-only period?
Whether you’re buying premises, bridging to a sale or facing the end of an interest-only term, the structure matters as much as the amount. Send us the basics in a form that takes about a minute. There’s no credit check when you send it, and it isn’t passed around to dozens of lenders. A real person reads it, works out what’s realistic and calls you. Be accurate about the security and the existing loan so the first suggestion is the right one.
Frequently asked questions
Do I pay less overall with an interest-only loan?
Usually not. Because the balance isn't reduced during the interest-only period, you pay interest on the full amount for longer, so total interest over the life of the loan is generally higher than on an equivalent principal and interest loan.
Can a business loan be interest-only for the whole term?
Yes, for short loans. Bridging finance, caveat loans and construction loans are commonly interest-only from start to finish, with the principal repaid from a sale, refinance or project completion. Longer business loans normally limit the interest-only period and then switch to principal and interest.
Is interest-only the same as capitalised interest?
No. With interest-only, you pay the interest as you go. With capitalised interest, the interest is added to the loan balance instead of being paid, so the debt grows. Some short-term lenders also take prepaid interest, deducted from the loan upfront.
Can I extend an interest-only period?
Sometimes. The lender will reassess the loan, including your income, the security and whether you can afford principal and interest repayments later. It isn't automatic, so start the conversation several months before the period ends.
Is interest on a business loan tax deductible?
Interest on money borrowed for business purposes is generally deductible to the business. The principal portion isn't. Your accountant can confirm how it applies to your structure and the loan's use.