When to Use Interest Only for Investment Property Loans

An investment loan for a new property purchase is typically structured to support both serviceability and tax position from the first settlement.

Truganina's position as a growth corridor west of Melbourne has drawn consistent investor interest over the past five years, particularly in newly completed house and land packages and townhouse subdivisions near Forsyth Road and the Leakes Road precinct. Buyers in the area are frequently weighing repayment structure, deposit funding, and the interaction between negative gearing restrictions and new build exemptions that came into force during the middle of last year.

What Lenders Assess When You Apply for a New Investment Property Loan

Lenders assess your capacity to service an investment loan at a rate 3.0 percentage points above the loan product rate. That buffer has applied since October 2021 and remains in place for all new borrowing through authorised deposit-taking institutions. Your total debt-to-income ratio is also measured. Since February this year, no more than 20 per cent of a lender's new investor loans may be written to borrowers with a DTI of six times or greater. For borrowers near that threshold, the difference between a salary of $120,000 and $130,000 can determine whether the application proceeds or requires additional equity.

Rental income is included in the serviceability calculation, typically at 80 per cent of the assessed market rent to account for vacancy and management costs. Truganina's proximity to employment hubs including the Laverton North industrial precinct and Derrimut logistics estates has supported tenant demand, but lenders will apply their own vacancy assumptions regardless of local conditions. Where a property is purchased off the plan and settlement is six months or more away, some lenders will require evidence of pre-lease or adjust rental assumptions downward if comparable evidence is limited.

How Deposit and Equity Requirements Differ for Investment Purchases

Most lenders cap investment loans at 90 per cent LVR, though some will lend to 95 per cent for specific borrower profiles or where the property is a new build.

Lenders Mortgage Insurance is payable on any loan above 80 per cent LVR. The premium is calculated on a sliding scale and added to the loan amount or paid upfront. For a loan of $500,000 at 90 per cent LVR, the LMI premium typically falls between $15,000 and $20,000, depending on the insurer and your income profile. That cost is not tax deductible as a direct borrowing expense, though it may be claimed as a deduction over five years or the term of the loan, whichever is shorter.

Investors who already own property often release equity rather than contribute cash. Where you are refinancing an existing home to access equity for a deposit, the borrowing is split across two securities. The portion secured against your existing property and used to fund the investment deposit is generally deductible against rental income, provided the funds are used for income-producing purposes. The portion secured against the new investment property is also deductible. Loan structuring becomes relevant at this point, and most investors separate facilities to preserve clarity for the ATO.

Interest Only Versus Principal and Interest for Investment Loans

Interest-only repayments reduce monthly outgoings and increase cash flow, which is why the structure remains common for investment loans.

Under an interest-only arrangement, you pay only the interest component each month. No principal is repaid during the interest-only period, which is typically one to five years. At the end of that period, the loan reverts to principal and interest unless you apply to extend the interest-only term. Not all lenders will approve extensions, and credit policy has tightened considerably since mid-2023. Where the original interest-only period exceeds five years and the LVR is above 80 per cent, the loan is classified as non-standard under the prudential framework, which increases the lender's capital cost and may result in a higher interest rate or declined application.

Principal and interest repayments are higher each month but reduce the outstanding balance over time. Some investors prefer this structure where rental income comfortably covers repayments or where they intend to pay down the loan within a fixed timeframe. The choice often comes down to whether you prioritise cash flow now or equity reduction over the loan term.

Consider an investor purchasing a three-bedroom townhouse in Truganina at 90 per cent LVR with a loan amount of $540,000. On a variable rate, monthly repayments on an interest-only basis might sit around $2,400. The same loan on principal and interest would require approximately $3,200 per month. If assessed rental income is $2,300 per month and the borrower has other investment income or salary to cover the shortfall, the interest-only structure improves monthly cash flow by around $800. That difference can determine whether the loan is serviceable within the lender's policy, particularly where the borrower is also carrying debt on an owner-occupied property.

Negative Gearing and the New Build Exemption in Truganina

Negative gearing allows you to deduct losses from rental property against other income, including salary, until the property is sold.

From the income year starting 1 July this year, losses on established residential investment properties purchased after 7:30pm AEST on 12 May last year can only be offset against income from other residential properties, not against wages. Losses can still be carried forward. The restriction does not apply to new builds, defined as dwellings constructed on previously vacant land or developments that increase the total number of dwellings on a site. A knock-down rebuild that does not increase dwelling numbers is not considered a new build for this purpose.

Truganina has seen substantial residential construction over the past three years, much of it on subdivided land that was previously semi-rural or industrial. Townhouses, duplexes and newly completed house and land packages in estates near Leakes Road, Forsyth Road and Palmers Road generally qualify as new builds provided they have not been occupied for more than 12 months before your purchase. If you are buying from an owner-occupier who lived in the property for 18 months, the property loses the new build exemption and the negative gearing restriction applies.

The new build exemption extends to capital gains tax as well. For properties that qualify, you can choose at the time of sale between the previous 50 per cent CGT discount or the new indexed cost base method with a 30 per cent minimum tax rate on real gains. Properties that are not new builds and are purchased after 12 May last year are subject to the indexed method for gains accruing from 1 July this year onward, with no option to revert to the 50 per cent discount for that portion of the gain.

Fixed or Variable Rate for a New Investment Purchase

Variable rates allow offset accounts, which can reduce the interest charged on your loan balance without affecting the deductibility of the full loan amount.

Offset functionality is relevant where you are holding surplus cash for future purchases, renovation costs, or as a buffer against vacancy periods. For investors with multiple properties, offset accounts provide flexibility to direct funds where they are most needed without triggering redraw restrictions or requiring a new loan application. Fixed rates do not support offset accounts but provide certainty over repayments for the fixed period, which is typically one to five years. Rate discounts vary depending on the lender, your LVR, and whether the loan is interest-only or principal and interest.

Some investors split their loan between fixed and variable. That structure allows partial access to offset while locking in a portion of the rate. Most lenders allow splits in increments of $10,000, and you can adjust the allocation at each fixed rate expiry. One consideration is the higher risk weighting applied to investment loans under the prudential standard. That weighting feeds into the lender's capital cost and is reflected in the interest rate margin, which is why investor rates sit above owner-occupier rates at the same LVR and loan type.

How Settlement Timing Affects Borrowing Capacity

Where you are purchasing a property off the plan with a settlement date more than six months away, your borrowing capacity is assessed at today's rates and policy settings, but the loan does not formally commence until settlement.

If your income, employment or debt position changes between approval and settlement, you are required to notify the lender. Most lenders will re-verify income and conduct a new credit check within 90 days of settlement. If your circumstances have changed materially, the lender may withdraw the approval or require additional security. For purchases in Truganina's newer estates, where construction timelines have occasionally extended beyond the contracted completion date, this can create problems for buyers who have taken on additional debt or changed employment in the interim.

Pre-settlement inspections are required under most contracts of sale in Victoria, and your solicitor or conveyancer will confirm that the property matches the plan of subdivision and that all fixtures specified in the contract are present. Lenders will also require a valuation at or near settlement to confirm that the property's market value supports the loan amount. Where the valuation comes in below the purchase price, you may be required to provide additional funds to meet the shortfall.

What Happens If You Cannot Meet Repayments After Settlement

If rental income does not cover your loan repayments and you cannot meet the shortfall from other sources, you are required to notify your lender as soon as possible.

Under the National Credit Code, a borrower under a regulated credit contract may give the lender notice of their inability to meet obligations, and the lender has 21 days to respond. That response may include a temporary reduction in repayments, a switch from principal and interest to interest-only, or a pause on repayments for a defined period. Hardship arrangements are assessed on a case-by-case basis and depend on your circumstances and the lender's policy. Investors who hold loans in a company structure or where the loan is provided predominantly for business or investment purposes may fall outside the National Credit Code, in which case the hardship provisions do not apply and any arrangement is at the lender's discretion.

For properties in Truganina, vacancy risk is a recurring concern raised by investors purchasing in streets with high concentrations of new rental stock. Where multiple townhouses in the same development are listed for lease simultaneously, time to lease can extend beyond the 30-day assumption used in most serviceability models. Holding three months of repayments in accessible savings provides a buffer, though that cash should not be included in your deposit calculation if it is needed for settlement costs or LMI.

Lexor Finance works with investors purchasing new and established property across Melbourne's growth corridors, including Truganina and surrounding suburbs. We structure lending to support your tax position, manage serviceability within current policy settings, and provide access to investment loan options from banks and lenders across Australia. Call one of our team or book an appointment at a time that works for you.

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