Interest Only Mortgages in New Zealand — Pros and Cons

Interest Only Mortgages in New Zealand — Pros and Cons

An interest only mortgage does exactly what the name says. You pay the interest each month and nothing off the principal, so the balance sits there untouched. The repayments look wonderfully small. That is the whole appeal, and it is also the whole problem.

Here is the thing that surprises most people we talk to. Interest only is not a fringe product for desperate borrowers. Plenty of ordinary New Zealand homeowners have used one at some point, usually for a year or two while cash flow was tight. The banks will lend on it. The question is whether you should.

We have written this guide for people weighing it up properly — investors, self-employed borrowers, and anyone staring at a repayment figure that has crept up faster than their income. There is a real case for interest only in the right circumstances. There is also a trap in the timing that catches people out, and we will get to that.

How We Researched This Guide

We built this from primary sources rather than lender marketing. The Reserve Bank's LVR and DTI pages gave us the bank-level speed limits, which are often misread as borrower entitlements. Inland Revenue's interest limitation guidance gave us the current deductibility position. We also read our own mortgage rate table, which held 268 rate rows across the lenders we track when we checked it on 16 September 2026.

One thing surprised us. Our table showed shorter fixed terms priced below longer ones on that date — the one-year median sat under the two-year median. That pattern matters enormously to anyone weighing a break fee, because the direction of rates since you fixed determines whether breaking costs you anything at all. The rules on early repayment costs are set out in full on legislation.govt.nz, and they are worth reading before you sign anything fixed.

The Quick Summary (60-Second Version)

If you only read one part of this page, read this bit.

• Interest only means lower repayments now and a loan balance that does not move. You are renting money from the bank instead of buying the house from it.
• Rates move daily. Our table on 16 September 2026 tracked one-year medians around 5.15% and two-year medians around 5.49%, but those are a snapshot, not a quote.
• Interest on residential rental property is fully deductible from 1 April 2025, provided the borrowing is not private in nature.
• Rental losses are ring-fenced. You cannot offset a rental loss against your salary, unlike in Australia.
• A break fee on a fixed loan is usually large when rates have fallen since you fixed, and near zero when they have risen. Most people assume the opposite.
• Every cashback carries a clawback period, commonly two to four years, and leaving early means repaying it.

How Interest Only Actually Works Here

A standard mortgage repayment has two jobs: cover the interest and chip away at the principal. An interest only repayment only does the first job. The principal stays exactly where it was on day one, so you have bought yourself time rather than equity.

Most New Zealand lenders structure this as a defined period — commonly a year or two, sometimes longer — after which the loan reverts to principal and interest. That reversion is where the trouble lives. Your repayment does not creep up. It jumps, because the same principal now has to be repaid over whatever term is left. If you have ten years remaining and you spent two of them paying interest only, you are squeezing the same debt into a shorter window.

What It Costs You Over Time

The long-term cost is straightforward and worth sitting with. Every dollar of principal you do not repay is a dollar still accruing interest. Stretch an interest only period out and the total interest bill climbs. You also delay the point at which you own the property outright.

There is a second cost that gets less attention: the low equity margin. Westpac's own help page describes a margin of typically 0.25% to 1.5% per annum added to the rate when you borrow more than 80% of the property's value. That is one bank's published range, not a market-wide figure, but it shows the shape of the pricing. On a $600,000 loan, a 0.75% per annum margin costs about $4,500 a year in extra interest. That arithmetic is an illustration, not a quote from any lender.

The Pros, Honestly Assessed

Interest only has genuine uses. It is not a loophole and it is not automatically reckless.

Cash Flow Relief When You Need It

The obvious benefit is breathing room. If you are between contracts, on parental leave, or carrying a renovation that has run over budget, a lower repayment for twelve months can be the difference between holding the property and selling it. That is a legitimate use.

It also suits borrowers whose income is lumpy rather than steady. Contractors and self-employed people often have months where the money simply is not there and months where it very much is. A lower committed repayment, paired with voluntary extra payments when cash allows, can work better than a rigid schedule.

The Investor Case

For property investors, the tax treatment matters. From 1 April 2025, 100% of the interest incurred on residential rental property can be claimed, provided the borrowing is not private in nature and the general deductibility rules are met. Before that, the interest limitation rules restricted claims from 1 October 2021 to 31 March 2025, and in the year to 31 March 2025 the deductible portion was 80%.

The Cons, and the Two Traps

The risks are not mysterious. They are just easy to postpone thinking about.

No Equity, and the Repayment Cliff

You build no equity through repayments. If the market is flat or falling, your position does not improve at all — it can worsen if values drop below what you owe. And when the interest only period ends, the repayment increase can be severe. Plan for that date from the day you start.

Trap One — Break Fees Run the Wrong Way

Under the Credit Contracts and Consumer Finance Act, you may repay a fixed loan early, and the lender may charge for the actual cost that results. The charge must be a reasonable estimate of that cost. Here is the part people get backwards: if rates have fallen since you fixed, the break fee can be large. If rates have risen, it is typically zero or negligible. A lender may also charge a flat administration fee for repaying the loan, separate from the early repayment cost.

You cannot calculate the figure yourself. The inputs vary by lender and are not published. Ask for a quote, and note that quotes are usually only valid for a few days.

Trap Two — Cashback Clawback

Cash contributions are commonly quoted at around 0.5% to 1% of the loan amount, and every one carries a clawback period — two to four years is common, and lenders vary. Clawback is generally triggered when the facility is closed or discharged in full, usually by refinancing elsewhere or selling without porting. A cashback is not free money. Compare total cost across the clawback period, not the headline rate.

Questions You Might Have

Can I get interest only with a 5% deposit?

Realistically, no. The Kāinga Ora First Home Loan needs only a 5% deposit and is underwritten by Kāinga Ora, with a 1.2% Lender's Mortgage Insurance premium instead of a low equity margin. But that scheme is built around getting buyers into principal and interest lending, not interest only structures. Interest only is generally a higher-equity product.

What happens when my interest only period ends?

The loan switches to principal and interest automatically, and your repayment rises. How much depends on your remaining term and balance. Some borrowers negotiate a further interest only period, but lenders reassess and there is no guarantee. Work out the new figure well before the change lands.

Is interest still tax deductible on a rental?

Yes, from 1 April 2025 you can claim 100% of the interest incurred, provided the borrowing is not private in nature and the general deductibility rules are met. Private or mixed-purpose borrowing must be apportioned. Interest is only deductible to the extent the borrowing relates to earning rental income.

Can I make extra payments while on interest only?

Often yes, though it depends on the lender and whether you are fixed or floating. Extra payments reduce the principal and therefore future interest, which is the main way to blunt the long-term cost. Check whether your lender allows it without an early repayment charge first.

Should I break my fixed loan to refinance?

Only after you have a break fee quote in hand. If rates have fallen since you fixed, the fee can wipe out the benefit of a lower rate entirely. Run the comparison over the full remaining fixed term, not one year. Quotes are typically valid only a few days.

What Matters Most

Interest only is a tool, not a strategy. It buys time, and time has a price. If you use it deliberately — for a defined period, with a written plan for what happens at the end — it can carry you through a genuinely tight stretch without forcing a sale.

What it cannot do is build equity for you. The principal you skip does not disappear. It waits, and it costs more the longer it waits. Anyone treating interest only as a permanent structure is quietly betting that capital growth will do the work their repayments are not.

So the honest test is simple. Can you say out loud what happens when the period ends, and can you afford it? If the answer is vague, stick with principal and interest. If the answer is specific and funded, interest only might genuinely be the right call.