An interest-only mortgage is a loan where you make interest payments for an initial term at a fixed interest rate. The interest-only period typically lasts for 10 years and the total loan term is 30. After the initial phase is over, an interest-only loan begins amortizing and you start paying the principal off for the remainder of the loan term at an adjustable interest rate.
Using an interest-only mortgage payment calculator shows what your monthly mortgage payment would be by taking into account your interest-only loan term, interest rate and loan amount. The result is your interest-only mortgage payment for the interest-only period and does not account for the principal payments you’ll make later when the loan beings amortizing.
After the initial period expires, the mortgage rate on an interest-only mortgage becomes adjustable, which can drive up your monthly payments considerably. That can lead to sticker shock for homeowners who don’t make any principal payments during the initial phase.
Once the interest-only period ends, you can refinance the loan, pay it off in full, or begin paying down the principal in monthly installments for the remainder of the loan term. Unless you were disciplined about making routine principal payments throughout the early payment period, your loan balance won’t go down -- and you won’t build equity.
For a $300,000, 30-year mortgage with a 10-year, interest-only period at a 5 percent interest rate, your interest-only monthly payment would be $1,250.00. A traditional loan payment at the same interest rate (with principal and interest factored in) would be $1,870 per month. The interest-only option would save a homebuyer $620 per month.
Interest-only mortgages tend to have a slightly higher mortgage rates than conventional loans to ease the lender's risk. These loans, which are considered non-qualified mortgages, are less common today because lenders have to keep them on their books and cannot resell them to Fannie Mae or Freddie Mac.
Borrowing requirements will vary from lender to lender so if you're looking for an interest-only mortgage, shop around to compare interest rates, fees and minimum requirements.
Here are some benefits of an interest-only mortgage:
Interest-only mortgages have risks and drawbacks, too. Here are some of them:
Interest-only mortgages are ideal for borrowers who want an affordable monthly mortgage payment and don’t plan on staying in a home more than a few years. If you have a fluctuating income -- earning significantly more in some months and less in others -- you also could benefit from making lower, interest-only payments.
An interest-only mortgage might be a good fit if you have: