Choosing the Right Home Loan: Fixed vs Variable, Principal & Interest vs Interest Only
- Jaeneen Cunningham
- 13 minutes ago
- 4 min read
When taking out a home loan, it’s easy to feel overwhelmed by the variety of options available. Two of the biggest decisions borrowers face are:
Fixed vs Variable Interest Rates
Principal & Interest (P&I) vs Interest Only (IO) Repayments
Understanding the differences between these loan types—and how they suit different personal and financial situations—can help you make the right choice and potentially save thousands over the life of your loan.
1. Fixed Rate Loans
A fixed rate loan means your interest rate (and repayments) are locked in for a set period, usually 1 to 5 years.
Pros:
Repayment certainty: You’ll know exactly what you need to pay each month.
Protection against rate rises: If interest rates go up, your repayments stay the same.
Good for budgeting: Ideal if you're on a fixed income or want financial stability.
Cons:
Less flexibility: Break costs can apply if you refinance or repay early.
No benefit from rate cuts: If rates drop, you’re still stuck with the higher fixed rate.
Limits on features: Offset accounts or extra repayments may be restricted.
When to choose a fixed rate:
You expect interest rates to rise.
You're on a tight budget and need predictability.
You’re a first home buyer nervous about fluctuating repayments.
Example:Emily, a first-time buyer, locks in a 3-year fixed rate at 5.89%. She knows exactly what her repayments will be each month and feels secure knowing she’s protected if interest rates rise.
2. Variable Rate Loans
With a variable rate loan, your interest rate can move up or down depending on market conditions (and decisions made by the lender).
Pros:
Flexibility: Easy to make extra repayments and access features like offset accounts.
Benefit from rate cuts: If rates fall, your repayments decrease.
Lower or no break fees: Easier to refinance or pay off early.
Cons:
Repayment uncertainty: Rates can rise, increasing your monthly costs.
Harder to budget: Unpredictable changes may affect your cash flow.
When to choose a variable rate:
You want flexibility and loan features.
You believe rates will stay stable or fall.
You plan to sell or refinance in the near future.
Example:David and Priya take a variable rate home loan with an offset account. They’re able to make lump-sum repayments when their income allows, and enjoy lower interest by keeping savings in their offset account.
3. Principal & Interest (P&I) Loans
With principal and interest repayments, you pay off both the interest charged and a portion of the loan balance (the principal) each month.
Pros:
You reduce your debt over time.
Lower total interest over the life of the loan.
Often lower interest rates compared to IO loans.
Cons:
Higher monthly repayments compared to interest-only loans.
Less cash flow flexibility in the short term.
When to choose P&I:
You're an owner-occupier wanting to build equity.
You want to pay off your home as quickly and efficiently as possible.
You don’t need to prioritise cash flow.
Example:James is buying a family home to live in. He chooses a P&I loan, knowing his repayments will reduce his debt steadily over 30 years.
4. Interest Only (IO) Loans
With an interest only loan, you only pay the interest charged on the loan for a set period (usually 1 to 5 years). After that, the loan reverts to principal and interest.
Pros:
Lower monthly repayments during IO period.
More cash flow flexibility—useful for investors.
Potential tax advantages (for investment properties).
Cons:
You don’t reduce the loan balance during the IO period.
Higher total interest paid over the life of the loan.
Potential repayment shock when the loan reverts to P&I.
When to choose IO:
You’re an investor aiming to maximise negative gearing benefits.
You have short-term financial constraints (e.g., maternity leave, new business).
You plan to sell the property before the IO period ends.
Example:Leah is purchasing an investment property. She chooses a 5-year interest-only loan so she can minimise repayments while she renovates and increases the rental yield. Her accountant confirms she can claim the interest as a tax deduction.
Home Loan Combining Options: Fixed and Variable + P&I/IO
You can often mix and match your loan structure. For example:
A fixed rate, interest-only loan for a property investor who wants stable repayments.
A variable rate, P&I loan for an owner-occupier who wants flexibility and to pay off their home faster.
You can also split your loan, fixing a portion while leaving the rest variable—this helps balance certainty with flexibility.
Example:Carlos splits his $600,000 home loan into two parts: $300,000 fixed for 3 years (for stability) and $300,000 variable (so he can make extra repayments and use an offset account).
Final Thoughts: Choosing What’s Right for You
There’s no one-size-fits-all answer when it comes to home loans. The right combination depends on:
Whether you're an owner-occupier or investor
Your cash flow needs
Your risk appetite
Your future plans
Market conditions and interest rate outlook
A mortgage broker can help:
An experienced broker can guide you through the options, explain the pros and cons based on your circumstances, and even help structure your loan creatively—like splitting or refinancing when the time is right.
Summary Table
Loan Type | Best For | Key Benefit | Considerations |
Fixed Rate | Budget-conscious borrowers | Certainty of repayments | No benefit if rates fall |
Variable Rate | Flexible, feature-focused users | Access to redraw/offset, lower break fees | Repayments can rise unexpectedly |
Principal & Interest | Long-term home buyers | Loan balance reduces over time | Higher monthly repayments |
Interest Only | Investors or short-term holders | Lower repayments during IO period | No debt reduction during IO period |
If you're unsure which loan structure is right for you, it's always wise to talk with a qualified mortgage broker like Etairos Finance who can assess your goals and recommend a tailored solution.
