Should You Switch From Interest‑Only To P&I Under New Tax Rules?

Most investors are asking the wrong question about their loans.

They’re still asking, “How do I maximise my negative gearing with interest‑only?” when the better question, after the 2026–27 tax changes, is: “How do I make sure my property portfolio still works if there’s no tax benefit — and then decide if interest‑only or P&I fits that plan?”

Put simply, switching from interest‑only (IO) to principal‑and‑interest (P&I) will make sense for more people under the new rules, but not for everyone and not all at once.

In this article I’ll show you how I walk clients through that decision in one working week.

What actually changes: why IO is weaker and P&I is stronger

The new tax landscape in one page

Here’s the short version of the 2026–27 reforms, based on Treasury and Budget papers:

1. Negative gearing on many established residential properties shrinks – especially for properties bought after 12 May 2026, where rental losses will be quarantined and may no longer fully offset wage income.
2. Capital gains tax (CGT) gets tougher – the 50% discount is replaced with inflation indexation plus a minimum 30% tax on most gains from 1 July 2027.
3. Policy intent has flipped – the system now clearly favours sustainable after‑tax cashflow and moderate gearing, not big pre‑tax losses chased for tax refunds. (See /insights/will-tighter-negative-gearing-rules-kill-property-investing-reality-check.)

This means the old play of stretching interest‑only as long as possible to “maximise deductions” on established properties is much weaker from a tax point of view.

Under these rules, debt reduction (P&I) becomes relatively more attractive because:

• you won’t be rewarded as much for running cashflow‑negative properties; and
• your real, inflation‑adjusted capital gains are now taxed more heavily, so the “it will all come good in growth” story is riskier.

I first spelt this out in detail in /insights/interest-only-vs-principal-and-interest-investment-gearing-cashflow-tax. This article is the “what do I actually do with my existing IO loans?” sequel.

IO vs P&I under the new rules: how the numbers really change

A worked example: $800k investment loan

Assume:

• $800,000 investment loan, 80% LVR
• Interest‑only rate: 6.4% p.a.
• P&I rate: 6.1% p.a. over 25 years
• Gross rent: $900 per week ($46,800 p.a.)
• Other costs (rates, strata, insurance, maintenance, management): $16,800 p.a.
• Marginal tax rate: 37% + Medicare

Scenario 1 – Interest‑only (IO)

• Annual interest: $51,200
• Net cash position before tax:
  • Rent $46,800 – costs $16,800 – interest $51,200 = –$21,200 (negative cashflow)
• Tax effect under old rules (simplified):
  • Deductible loss $21,200 × 37% ≈ $7,844 tax saving
  • After‑tax cash loss ≈ $13,356

Under new rules for many established properties bought after 12 May 2026, much of that loss may be quarantined, meaning the wage offset is limited or deferred. Your after‑tax loss could be closer to the full $21,200.

Scenario 2 – Switch to P&I

• Annual P&I repayment (6.1%, 25 years) ≈ $62,600
• Implied interest in early years ≈ $48,000; principal ≈ $14,600
• Net cash before tax:
  • Rent $46,800 – costs $16,800 – repayment $62,600 = –$32,600 out of pocket
• Deductible portion is interest only ($48,000), not the full repayment.

So why can this still be smarter?

1. You’re losing $32,600 cash, but $14,600 is forced saving reducing your debt.
2. Your tax deduction is slightly smaller (less interest), but:
   • that deduction is worth less under the new negative gearing rules anyway; and
   • every year your interest bill falls, improving after‑tax cashflow.

What I tell my clients: Compare IO vs P&I on what you keep in your pocket after tax over 5–10 years, and include the reduced loan balance as a benefit. Under the new rules, P&I often wins that race faster than people expect.

For more large‑loan modelling, see /insights/interest-only-vs-principal-and-interest-3-5-million-mortgage.

When does it make sense to switch IO to P&I now?

1. Your after‑tax cashflow is marginal even on IO

If your portfolio is already tight on IO, remember lenders must test you at 3% above current rates (APRA buffer). If:

• you’re stretched now; and
• tax benefits will shrink from 2027;

then hanging on to IO is often just delaying the pain.

Rule of thumb: If you wouldn’t be comfortable making the eventual P&I repayment today, you’re probably over‑geared for the new rules.

2. You have “grandfathered” and “new rules” properties mixed together

From a tax and risk perspective, most households will end up with three buckets:

1. Home loans (non‑deductible) – you want these cleared fastest.
2. Grandfathered investment loans – existing properties where old negative gearing rules largely continue.
3. New rules investment loans – especially established properties bought after 12 May 2026.

In this world, IO is least attractive on bucket 3. If you have to choose where to start switching to P&I, those are usually first.

3. You’re self‑employed or income‑volatile

The mistake I see most from self‑employed clients is assuming they’ll always be able to refinance out of trouble.

Banks already apply shading to business income and test at stressed rates. Add in:

• higher actual repayments when IO terms expire; plus
• reduced tax benefits from 2027;

and it becomes much harder to “roll” IO into fresh IO.

For many business owners, the smarter play is:

• keep some IO on high‑quality, grandfathered assets; but
• switch more marginal or new‑rules properties to P&I earlier, building equity and improving future servicing.

I go deeper on timing the switch in /insights/switching-between-interest-only-and-principal-and-interest.