An interest-only mortgage is a type of home loan in which the borrower only pays the interest on the loan for a specified introductory period. After this interest-only period concludes, the borrower must pay both interest and principal for the remainder of the loan term.
Interest-only loans have several benefits, including making monthly mortgage payments initially more affordable. On the other hand, there are some drawbacks—like higher payments once the interest-only period concludes—that borrowers will need to consider as well. Use this interest-only calculator to see how much one of these loans might cost you.
How To Use This Interest-Only Mortgage Calculator
To use this interest-only mortgage calculator, you’ll need to gather some basic information including:
- Loan amount
- Down payment
- Interest-only loan term (in years)
- Fully amortizing loan term (in years)
- Interest-only loan interest rate
- Fully amortizing loan interest rate
The calculator will then give you an estimate on how much you will pay monthly during the interest-only period, how much your monthly payments will be once the interest-only period ends and converts to the amortization phase, and how much you will pay over the entire loan term.
What Is an Interest-Only Mortgage?
An interest-only mortgage is a type of loan where you only need to pay the interest portion of your loan principal—at first.
In most cases, interest-only loans begin with a designated period that can range between three and 10 years. During this phase, you only pay the interest on the loan, or the cost of borrowing money from the lender. Once this interest-only phase ends, the loan moves into an amortized schedule, during which you pay both the interest and principal for the remainder of the loan.
For borrowers who want to buy an investment property or keep their monthly payments low for a set period, an interest-only loan could be a good option. However, there are trade-offs that come with those initial lower payments.
For one, interest-only mortgage rates tend to be higher than rates for conventional mortgages since mortgage lenders consider them a bigger risk, so you may end up paying more in interest over the life of the loan. Additionally, because you only pay interest at the outset, you don’t immediately begin to accumulate home equity as you would with a conventional mortgage.
How an Interest-Only Mortgage Works
Not everyone qualifies for an interest-only mortgage. These loans tend to have stricter underwriting requirements compared to conventional loans and are geared more towards borrowers with the financial background and assets to qualify for much larger loan amounts.
There are several ways interest-only mortgages are structured, but the most common interest-only loans are structured similarly to adjustable-rate mortgages (ARMs).
With an “interest-only ARM,” you make interest-only payments at a fixed interest rate during the loan’s introductory period. Once the introductory period concludes, you must pay interest and principal for the remainder of the loan at the market rate, which can fluctuate up or down.
For instance, with an interest-only 5/1 ARM, the interest rate remains fixed for five years (represented by the “5”). After that, the rate adjusts once every year (represented by the “1”) for the rest of the loan term based on the movements of a benchmark interest rate, such as the Secured Overnight Financing Rate (SOFR), plus a predetermined number of lender-added percentage points (the margin).
Alternatively, there are also fixed-rate interest-only loan products, but these are less common. With fixed-rate interest-only loans, the interest rate remains the same for the entire loan term.
The Monthly Payment Difference After the Interest-Only Period Ends
How much monthly payments increase after the expiration of the interest-only period depends on several factors, such as loan type, loan amount, if the borrower made additional payments during the initial phase of the loan, interest rates and interest rate changes, if applicable.
Nevertheless, let’s take a look at a basic example to see what you could generally expect with one of these types of loans.
Say you get a 30-year jumbo interest-only loan of $700,000 at 6% interest with a 10-year introductory period. Your monthly costs will come out to around $3,500 (0.06 × $700,000 / 12 months). Once the initial period expires, assuming you made no principal payments during the introductory period and the remaining 20-year period on the loan were to retain a 6% interest rate, your monthly principal and interest payment would shoot up to roughly $5,015.
This jump occurs not only because you are now paying principal, but because your principal is amortized over 20 years rather than spread out over the 30 years of the loan. And remember, there’s no guarantee that your interest rate will stay the same or decrease for the remainder of the loan term.
During the amortization phase, the payment structure is similar to a conventional mortgage in that the interest portion of your payment gradually goes down over time as the principal portion increases. This is the phase when you build up home equity.
Options To End an Interest-Only Loan
If you don’t want to keep the loan after the end of the interest-only period, you have a few options:
- Refinance the loan once the introductory period expires
- Pay off the remainder of the loan in a lump sum
- Sell your property to pay off the loan
Though this may be a tall order, if you want to keep the loan but need a little more time to improve your finances in order to make the interest and principal payments, it could be worth asking your lender what the potential options are, if any, to extend your loan’s interest-only period.
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How To Get an Interest-Only Mortgage
Some of the financial institutions such as banks, online lenders and credit unions that offer conventional mortgages also offer interest-only mortgages.
Even so, interest-only mortgages are less common than more traditional home loans. You may need to reach out to multiple lending officers to find out if interest-only mortgages are available.
Additionally, because interest-only loans are non-conforming loans—meaning they don’t fall within the guidelines of government-sponsored enterprises like Freddie Mac and Fannie Mae—most lenders will typically only offer jumbo interest-only loan products.
While there are no standard requirements for interest-only mortgages, these loan products come with a lot of risk. Consequently, lenders usually require borrowers to have a high credit score, a substantial amount of cash reserves, a high income and stable employment.
Is an Interest-Only Mortgage Right for Me?
As stated earlier, an interest-only loan is not right for everyone. Not only are there often stricter borrower requirements, but the drawbacks of this type of loan may outweigh the benefits. Make sure to speak with a knowledgeable loan officer who can advise you on the various interest-only mortgage options and which, if any, are right for you.
Here are some pros and cons to keep in mind when considering taking out an interest-only mortgage:
| Pros | Cons |
|---|---|
|
Low, interest-only monthly payments during the introductory period
|
No accumulation of home equity during the interest-only period
|
|
Smaller initial monthly payments allow borrowers to “afford more house”
|
When the interest-only period ends, the monthly principal and interest payments can be too burdensome for some
|
|
More funds available at the outset to use for expenses or to build net worth through investments
|
Interest rates could rise after the interest-only period, leading to higher total interest costs on the life of the loan
|
|
Option to make additional payments towards loan principal during interest-only phase to reduce monthly payments after interest-only period ends
|
More restrictive underwriting requirements compared to conventional loans
|
|
Potential tax savings on mortgage interest
|
The property value could depreciate to a point that the sale would not cover the cost of the loan
|
Bottom Line
Interest-only loans can make a lot of sense for some people. After all, paying only interest up front can make it easier to afford a home by lowering costs for the first few years of a loan, freeing up funds that borrowers can apply elsewhere. This type of loan could also be the right fit for people who have investment properties that they rent out to generate extra income and then flip after a few years.
Even so, all borrowers lulled by the siren song of only having to pay interest at the outset should think twice—if not more—about whether taking out an interest-only mortgage is a wise move.
For instance, if you don’t expect a meaningful increase in income, you’re worried about your ability to manage higher payments later in the loan term or you want to begin building equity in your home right away, an interest-only mortgage is probably not going to be the right loan for you.
Frequently Asked Questions (FAQs)
Who offers interest-only mortgages?
Private lenders offer interest-only conventional and jumbo home loans, and these are usually structured like ARMs. A single-family primary or secondary home can be eligible.
You may also qualify for an interest-only home equity line of credit (HELOC) where you don’t make principal payments during the draw period. Existing homeowners can consider this product when they want to borrow money without refinancing their existing mortgage to minimize closing costs.
How do you calculate an interest-only mortgage payment?
Start by multiplying your loan balance by your current interest rate. Then, divide it by the number of payments over the next 12 months. As a quick example, your monthly interest payment would be $1,750 on a $300,000 loan with a 7% interest rate.
What is the current interest rate for interest-only mortgages?
You’ll want to compare adjustable-rate mortgage rates to find your best interest-only option. Rates are currently hovering in the mid-to-upper 6% range for the following terms:
- 5/1 ARM
- 7/1 ARM
- 10/1 ARM
Is it easier to qualify for an interest-only mortgage?
It’s usually more challenging to qualify for an interest-only mortgage than a traditional home purchase loan as lenders typically require a credit score closer to 700, whereas most lenders only require a score between 580 and 620 for conventional and government-backed programs.
