Principal and interest: Paying off your home loan

What is principal and what is interest?

The principal of your home loan is the amount of money you borrow from your bank or lender.

The interest is the cost charged by the bank or lender to you to borrow this money. The interest rate on your home loan, the loan term and the amount of your repayments will determine how much you end up paying back over the life of the loan.

Principal and interest home loans

A home loan with repayments of both principal and interest is one in which you pay interest and also repay part of the amount borrowed (principal) at the same time.

One of the benefits of selecting a principal and interest home loan from the beginning of the loan term is that your repayments will be lower over the life of the loan, since each time you pay the minimum repayment you’re chipping away at the principal loan amount while also covering the interest.

Your home loan will come with a specified term in which it is to be repaid – typically no longer than 30 years. The lender will usually work out the minimum principal and interest repayments needed to repay the loan within the selected term.

Interest-only home loans

As the name suggests, you only have to pay the interest on this type of loan during the interest-only period. This means your payments over this time will be less than if you were also repaying the principal. However, the principal amount will remain the same – that is, your outstanding balance won’t be reduced – unless you choose to make extra repayments.

It also means that your repayments will be higher when the interest-only period ends and may be more expensive over the life of the loan.

One key consideration around interest-only home loans is that you do not build any property equity during the interest only period as the principal is not reducing.