Interest-Only Mortgages: When They Work—and When They Don’t
Interest-only mortgages tend to get a bad rap, and not without reason. Used recklessly, they can lead to financial stress and ballooning debt. But in the right circumstances, with the right strategy, they can be a very smart move—especially for investors or those managing short-term cashflow pressures. Let’s look at how they work, when banks allow them, and when you should steer clear.
Why Banks Are Cautious About Interest-Only Mortgages
Banks in New Zealand are required to lend responsibly, and that means encouraging borrowers to actually reduce their debt—not just service the interest. The Reserve Bank takes a dim view of long-term interest-only lending, especially for owner-occupiers nearing retirement. As a result, most banks will only allow interest-only terms for a limited time: typically two years for owner-occupied homes and up to five years for investment properties.
Are Interest-Only Mortgages Still Available?
Yes—but they’re declining in popularity. In June 2021, interest-only loans made up 24.7% of new mortgages, although this figure is influenced by revolving credit accounts that are always interest-only (particularly ANZ’s Flexi product). Strip those out and the number is closer to 20%.
Zooming out, interest-only loans made up 29.8% of all mortgages in 2020, but just 20.9% a year later. Go back further, and it was 38% of new lending in 2016. The overall trend is downwards, driven largely by tighter lending rules and the phasing out of tax deductibility for many property investors.
When Interest-Only Makes Financial Sense
There are sound reasons to choose an interest-only structure in the short term. Here are a few:
1. Paying off higher-interest debt
If your mortgage is 7% but your credit card is 20%, it’s clear where your money should go. Going interest-only frees up cash to knock back expensive short-term debt—so long as you don’t run the balances back up again.
2. Repaying a family loan
Many first home buyers get help from parents, often with the understanding that repayment comes first. Switching to interest-only can be a temporary solution that gives you breathing room to honour that agreement.
3. Managing cashflow during major life events
Starting a business, having children, or taking parental leave can all create short-term income drops. Interest-only loans can help you manage these periods without falling behind.
The Investment Strategy Angle
Historically, property investors structured their lending so that personal home loans were paid down first, while investment loans remained interest-only (because the interest was tax-deductible). Since March 2021, however, the Government has begun phasing out that tax benefit.
Still, some investors continue with this strategy for two reasons:
Properties purchased before March 2021 retain some deductibility until 2025.
A future government may reintroduce the tax deduction, in which case this structure would again be optimal.
The bottom line? If you're choosing interest-only, you should have a clear financial reason—and a plan for what happens next.
Restrictions and Reversions: What to Expect
Once your interest-only term expires, the bank will usually automatically switch the loan to principal and interest. At most banks, this happens seamlessly. ANZ, however, requires a new account to be set up at rollover—if you forget to do this, their system may try to pay off the loan in full (a paperwork glitch, not a hidden penalty).
If you want to extend your interest-only term, you’ll need to apply again. Be prepared for more scrutiny if you’re over 50—banks are cautious about older borrowers deferring principal payments, especially as they near retirement.
High LVR? You’ll Struggle to Get Approved
If your loan-to-value ratio (LVR) is over 80% and you’re applying for an interest-only loan on your owner-occupied home, most banks will say no. At high LVRs, you’re more exposed if the market drops—so lenders want to see you actively reducing your debt.
Once you’re under the 80% threshold, banks are more flexible and view you as lower risk.
Can You Still Make Extra Payments?
Yes, in many cases you can. Just because your loan is structured as interest-only doesn’t mean you’re locked out of principal repayments. Most banks allow either regular overpayments or lump sums without penalty—even on fixed-rate loans. Just check the conditions first with your broker or lender.
Who Should Consider Interest-Only Mortgages?
Interest-only loans aren’t for everyone. But they can be useful if:
You have a mixed portfolio and want to keep the investment debt high (for tax reasons)
You need to prioritise other debts in the short term
You’re being forced to switch back to principal and interest, but you’d be better off staying interest-only for now
In any of these scenarios, speak to your mortgage broker and, if applicable, your accountant. The key is to be proactive—banks don’t typically extend interest-only terms automatically.
Make a Plan Before the Clock Runs Out
Whether you’re approaching the end of your interest-only term or just considering one for the first time, the smartest move is to build a long-term strategy. Interest-only loans should always be a tool, not a lifestyle. When used right, they can help you unlock capital, invest elsewhere, or smooth out your finances. But without a clear plan to eventually reduce your debt, they can just delay the inevitable.
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