An interest-only mortgage lets you pay only the interest for a set period, typically 5-10 years. After that, you start paying principal and interest (fully amortizing) for the remaining term. The initial payments are lower, but you build no equity during the interest-only period. These loans suit investors and high-income borrowers who expect their income to increase.
How an Interest-Only Loan Works
For the first 5-10 years, you pay only the interest that accrues each month. No principal is paid down. After the interest-only period ends, the loan converts to a fully amortizing payment. The remaining balance is spread over the remaining term, so the payment increases significantly. On a $300K loan at 7%, the interest-only payment is $1,750/month. After the IO period, the full P&I payment is about $2,225/month for a 20-year remaining term.
Risks of Interest-Only Loans
No equity build-up during the interest-only period. If property values drop, you could owe more than the home is worth. Payment shock when the IO period ends. Harder to qualify due to stricter underwriting. Higher rates than standard loans. If you do not have a plan for the payment adjustment, you could face financial strain.
Who Benefits from Interest-Only Loans
Real estate investors who plan to flip or refinance within the IO period. High-income earners with variable compensation who want lower initial payments. Borrowers who expect significant income growth. Homeowners who plan to sell before the IO period ends. These loans are not for first-time buyers or anyone on a tight budget.