Should You Use Interest-Only on an Investment Property? The Pros, Cons, and What the Banks Think
If you've ever asked yourself whether you should switch your rental property to interest-only, you've probably had two very different answers land on your desk at the same time. Your accountant might be nodding along. Your bank might be quietly less enthusiastic. Both are right, and that's exactly why this decision trips up so many investors.
Interest-only lending on an investment property comes up constantly in portfolio-building conversations, and there's a good reason for that: it genuinely can support the way you grow a portfolio. But it's not free. What it gives you in cash flow, it can cost you in borrowing power down the track. This article isn't here to tell you whether to use it. It's here to walk you through why investors consider it, where the trade-offs actually sit, and what to ask before you commit to a term.
What "interest-only" actually means
On a standard principal and interest (P&I) loan, every repayment chips away at both the interest charged and the amount you originally borrowed. On interest-only (IO), your repayment covers the interest only, so the loan balance doesn't reduce during that period. Most banks will offer an interest-only period of somewhere between one and ten years at a time on investment lending, after which the loan reverts to P&I over the remaining term, unless you apply to extend it.
That single mechanical difference, no principal reduction, is where every benefit and every downside in this article comes from.
Why investors consider interest-only
There are two main reasons this comes up in almost every portfolio conversation.
Keeping debt working for you, not against you
The money you've put into an investment property is there to generate a return. Whether that return shows up as rental yield, capital growth, or both, the principle is the same: capital sitting in a mortgage isn't working for you elsewhere. Every dollar you pay down in principal is effectively money taken off the table and parked in the property.
There's nothing wrong with that. It's just worth naming what it is: a forced savings plan. You're building equity steadily and safely, and for a lot of people, that's exactly the right approach.
But here's where it's worth pausing before assuming interest-only is automatically the "growth" choice: the real question usually isn't whether you pay down principal. It's where.
If you're actively growing a portfolio, retaining equity as usable leverage rather than locking it into principal repayments on the rental is often the more deliberate move. Interest-only frees up cash flow, and that freed-up cash flow gets redirected toward the next deposit, or held in an offset or revolving credit facility so it's ready when the next opportunity comes along. Here, the goal is genuinely to keep capital mobile.
If you've got one investment property and no immediate plan to buy another, the calculation often looks different. In that scenario, the smartest use of the cash flow interest-only frees up usually isn't to let it sit idle, it's to direct it toward paying down your own home loan instead.
Your owner-occupied mortgage is non-deductible debt. Your rental debt, assuming it's structured correctly, is deductible. All else equal, it makes more sense to attack the debt that isn't giving you anything back at tax time first, and let the deductible debt sit on interest-only in the meantime. This is sometimes called debt recycling, and it's a conversation worth having with your accountant and adviser together, because getting the structure right matters as much as the strategy itself.
What good looks like: Before you choose interest-only, know exactly what you'll do with the cash flow it frees up. "I'll figure it out" isn't a plan, whether you're scaling a portfolio or holding steady with one or two properties.
Watch out: interest-only doesn't just delay principal repayment, it means you pay more interest over the life of the loan, full stop. Because the balance isn't reducing during the interest-only period, you're paying interest on a higher balance for longer than you would on P&I. A genuinely smart strategy, redirecting the freed-up cash flow into the next deposit, an offset facility, or your non-deductible home loan, will usually offset that extra cost and then some. But that only happens if the freed-up cash flow is actually put to work. Left to just top up everyday spending, interest-only quietly becomes the more expensive option with nothing to show for it.
The tax deductibility angle (talk to your accountant first)
Here's the part that often gets missed: whether your mortgage interest is tax-deductible depends on what the borrowed money was used for, not on whether the loan is interest-only or P&I. Deductibility comes down to purpose. If the debt was taken out to acquire or improve an income-producing property, the interest is generally deductible, even if that debt happens to be secured against your own home rather than the rental itself. Plenty of investors assume that because a loan sits against their family home, it can't be claimed. That's not automatically true. It's the use of the funds that matters most, not the security.
This becomes especially relevant when you've drawn a deposit from equity in your home to buy a rental. That portion of debt is doing an investment job, so it's usually treated as investment debt for tax purposes, subject to your accountant confirming the details and how it's structured.
Where interest-only genuinely helps here is cash flow, not deductibility itself. Since 1 April 2025, interest on residential rental lending is once again 100% tax-deductible for most investors, after several years of the previous government's interest limitation rules phasing that out. That's a meaningful shift if you bought during the restricted years and are only now reviewing your structure. But full deductibility applies whether you're on interest-only or P&I. The genuine IO advantage is that it frees up cash flow now, which matters most for lending that isn't earning its keep, for example, debt secured against an under-occupied property, or lending where the numbers are already tight.
What good looks like: Knowing exactly which portion of your debt is investment- related and which is personal, so your accountant can confirm what's deductible and you're not guessing at tax time.
The trade-off: better cash flow now, tighter borrowing later
This is the part that doesn't get talked about enough, and it's arguably more important than the tax question.
From a bank's perspective, an interest-only period actually works against you.
When a lender assesses your ability to service a loan, they look at your repayments over the full term, on a principal and interest basis, even during any period you intend to have it structured as interest-only. A five-year interest-only period effectively compresses your remaining loan term into fewer years of principal repayments once it reverts, which pushes up the assessed repayment amount and tightens what you can borrow elsewhere in your portfolio.
In other words: the same feature that improves your day-to-day cash flow can reduce your overall borrowing capacity on paper. There's a genuine discrepancy between what interest-only does for your cash flow and what it does for your next application, and it's worth sitting with that before you ask for the longest term on offer.
Watch out: the longer the interest-only period, the bigger this effect. Locking in ten years upfront because it's available doesn't mean it's the right length for your goals, especially if you're planning to keep buying.
A strategy that often works better if you're trying to preserve borrowing capacity is starting with a shorter interest-only term, say one or two years, with the ability to apply for an extension later, rather than locking in the maximum five to ten years from day one. You keep the door open without immediately taking the full hit to your servicing.
How banks actually treat interest-only (it's not consistent)
Every lender approaches interest-only slightly differently, and this is where a broader market view matters.
Term length varies by lender. Most banks will offer somewhere in the range of one to five years upfront on investment lending, and some will go further. There's no single industry standard.
Some banks assess based on the intent of the lending, and others assess based on the security the debt sits against. This matters most when you're using split banking, for example, drawing a deposit against your own home to buy a rental. Some lenders will treat that portion as investment lending because that's what it's funding. Others will treat it as owner-occupied debt because that's what it's secured against. Which approach your bank takes can directly affect how long an interest-only term you're able to get on that portion.
Getting a shorter deposit-side facility with the ability to extend is often more achievable than trying to get the full term upfront, particularly at banks that take the security-based view.
None of this is a reason to avoid split banking. It's a reason to have the conversation about interest-only terms as part of the structuring discussion, not as an afterthought once the deal is done.
A few current market factors worth knowing
A handful of settings in the current lending environment shape how much this all matters in practice.
Debt-to-income (DTI) restrictions have applied to investment lending since July 2024, generally capping investors at seven times gross income. This sits alongside, not instead of, the bank's own serviceability assessment. At today's interest rates, most investors aren't actually bumping up against this ceiling, serviceability tends to bite first, but it's a cap on how far leverage can be pushed as rates move and portfolios grow.
Deposit requirements for investors currently sit around 30% at most banks, though it's not unheard of for strong applicants to secure lending with a smaller deposit, around 10% in some cases, provided the overall affordability is solid. A lower deposit requirement can be genuinely valuable if you're planning to keep growing a portfolio, because it leaves more equity in reserve for the next purchase rather than tying it all up in one property. If you're weighing this up alongside a split banking strategy, it's worth reading our dedicated article on how that structuring works: Split Banking in NZ: What Every Property Investor Should Know
None of these settings change the fundamental interest-only decision on their own, but they shape how much room you have to move, and they're worth understanding as part of the bigger picture.
Is interest-only right for you? A few questions to ask
Rather than a yes or no answer, here's a self-check worth working through, ideally with your accountant and your financial advisers in the same conversation:
Do you have a clear plan for what you'll do with the extra cash flow, or will it simply be absorbed into day-to-day spending?
Are you planning to buy again in the next few years, and if so, have you modelled how an interest-only period affects your assessed borrowing capacity at that point?
Do you have any non-deductible mortgage debt, such as that used for purchasing or improving your owner-occupied home?
Have you asked your accountant to confirm which portions of your lending are investment-purpose, particularly if you've used equity from your own home?
Would a shorter interest-only term with the option to extend suit your goals better than locking in the maximum term now?
The honest takeaway
Interest-only isn't inherently good or bad. It's a tool that trades reduced principal repayment now for stronger ongoing cashflow and retained leverage, and whether that trade makes sense depends entirely on what you're trying to achieve. As your adviser, it's not my place to tell you whether you should use it. What I can do is make sure you understand both sides of that ledger, and point you toward the accountant or investment adviser who can help you decide how it fits your wider plan.
If you'd like to talk through how an interest-only structure would actually affect your borrowing capacity and your next purchase, get in touch and we can run the numbers together.
This article is general information only and isn't personalised financial advice. Lender criteria and government settings can change, and what's right for you depends on your circumstances. Please get advice from your accountant and financial adviser before making decisions.
