Quick answer
Principal-and-interest repayments are the better default for most business loans, because every repayment reduces the debt and the loan is cleared by the end of the term. Interest-only suits short-term borrowing with a defined exit, such as a property sale or refinance, or a temporary period while a new investment ramps up. Interest-only without a clear plan for the principal is the risky combination.
Key points
- Principal and interest reduces the debt with every repayment.
- Interest-only keeps repayments lower but the full balance remains owing.
- Interest-only fits short terms with a dated exit, or a set ramp-up period.
- Always plan how the principal will be repaid before choosing interest-only.
- Default choice
- Principal and interest
- Short term with exit
- Interest-only
- Must have
- A plan for the principal
Two loans for the same amount, from the same lender, can feel completely different month to month depending on one setting: whether your repayments include principal or only interest. It’s a choice that affects your cash flow, your total cost and how exposed you are at the end.
How do the two repayment types work?
Principal and interest (P&I). Each repayment covers the interest for that period plus part of the amount borrowed. The balance shrinks over time and reaches zero at the end of the term.
Interest-only (IO). Repayments cover the interest only. The balance stays where it started. At the end of the interest-only period, you repay the whole amount, refinance it, or switch to P&I for the remaining term.
How do they compare?
| Test | Principal and interest | Interest-only |
|---|---|---|
| Regular repayment | Higher | Lower |
| Balance over time | Falls steadily | Stays the same |
| Total cost over the loan | Usually lower | Usually higher |
| End of term | Debt cleared | Full balance due or refinanced |
| Suits | Most long-term business borrowing | Short terms with an exit; temporary ramp-ups |
| Main risk | Tighter monthly cash flow | Exit fails and balance is still owed |
Our verdict
Our verdict: principal and interest by default, interest-only only with an exit
- P&I is best for
- Equipment, fit-outs, acquisitions, refinanced debts: anything repaid from trading over years.
- Interest-only is best for
- Bridging and caveat loans repaid from a sale or refinance, and short ramp-up periods before switching to P&I.
- Check before you sign
- When the IO period ends, what repayments jump to afterwards, and exactly how the principal will be repaid.
P&I wins for most business borrowing because it builds in discipline. Every repayment reduces the debt, so you finish the term owing nothing, and the total cost is lower than carrying the full balance for longer.
Interest-only wins when the principal will be repaid in one hit. A bridging loan cleared by a property sale, or a short-term second mortgage repaid by a refinance, doesn’t need monthly principal reductions: the lump sum is coming. Paying interest only keeps monthly cash flow clear in the meantime.
Interest-only for a ramp-up period can also make sense: the first months of a new site or a big hire, before switching to P&I. Just make sure the switch is in the contract and you’ve tested the higher repayment against your cash flow.
The old 12-month interest-only second mortgage is a classic short-term structure. Read our second mortgage verdict for when it fits. Or talk to a specialist about your repayment options.
Illustrative examples
Illustrative only.
A property developer’s business needs funds to complete a project, with a contract of sale on the finished units. Interest-only for the short term, repaid in full at settlement. Verdict: interest-only.
A manufacturer borrows to buy a second production line, repaid from the extra output over several years. Verdict: P&I from the start.
A gym opening a second location takes a loan with a short interest-only period while memberships build, then P&I for the remaining term. Verdict: a short IO period with a fixed switch date.
What should you watch for with interest-only?
- The end date. Know exactly when the interest-only period stops.
- The repayment jump. When P&I starts, repayments rise, sometimes sharply.
- The exit. If the plan is a sale or refinance, what happens if it’s delayed?
- Total cost. Put both structures into the total cost comparer using total repayments, fees and any balance owing at the end.
For the related choice of term length, see short-term versus long-term loans. For structures that commonly run interest-only, read our verdicts on bridging loans and caveat loans.
How do repayments change when interest-only ends?
The jump can surprise people. During the interest-only period, repayments cover interest on the full balance. When principal-and-interest repayments start, two things happen at once: you begin paying down the balance, and you do it over a shorter remaining term than if you’d started on P&I. Both push the repayment up.
Illustrative only: an owner takes a loan with a short interest-only period at the start. When it ends, the repayment rises noticeably because the whole balance must now be cleared in the years remaining. If the business has grown as planned, that’s fine. If it hasn’t, the new repayment can bite.
The fix is simple: before you choose interest-only, ask the lender for the repayment that will apply once it ends, and test it against your quietest month.
Common mistakes
- Choosing interest-only for comfort on a long-term loan, then never switching.
- No written exit for a short interest-only loan.
- Assuming a refinance will be available at the end without checking what a future lender would need.
- Comparing only repayments rather than total cost over the life of each option.
Questions to ask before choosing interest-only
What exactly ends the interest-only period, what will repayments be afterwards, and what happens if the planned sale or refinance is delayed? Get the answers in writing.
Which repayment type fits your plan?
Tell us what you’re funding and how you’ll repay it. Start an enquiry in about a minute and a specialist will suggest the repayment structure that suits.
There’s no credit check just for asking, and you deal with one specialist rather than a parade of lenders. Be clear about your exit if you have one; it’s what makes interest-only either sensible or risky.
Frequently asked questions
What is an interest-only business loan?
During the interest-only period, repayments cover only the interest. The amount borrowed stays the same and must be repaid at the end, by refinancing, selling an asset or switching to principal-and-interest repayments.
Is interest-only cheaper?
Repayments are lower during the interest-only period, but because the balance doesn't fall, you pay interest on the full amount for longer. Over the life of the loan, it usually costs more.
When does interest-only make sense for a business?
When the term is short and the exit is clear, such as a bridging or caveat loan repaid from a sale, or for a limited period while a new site or hire ramps up, switching to principal and interest afterwards.
What's a 12-month interest-only second mortgage?
A second mortgage where repayments cover interest only for 12 months, with the balance due at the end. It suits a defined, short-term need with a clear way to repay or refinance.