Interest-Only Mortgages

An interest-only mortgage lets you pay only the interest on your loan for a specific period, typically 5 to 10 years, without having to pay down the principal. This can be an attractive option for borrowers looking for lower monthly payments or those with unpredictable incomes.

What Are Interest-Only Mortgages?

How Interest-Only Mortgages Function

These loans are available in fixed-rate, adjustable-rate (ARMs), or option ARMs formats. For the interest-only period, your monthly payments will only cover the interest. Once the interest-only term ends, the loan will convert to a fully amortized mortgage, resulting in a significant increase in your monthly payment. The longer the interest-only period, the greater the increase when the full payments begin.

Equity Building Considerations

The primary disadvantage of an interest-only mortgage is that you don't build any equity in your home during the interest-only period. However, this option may allow you to purchase a more expensive property than you could afford with a traditional mortgage.

Interest-only mortgages are typically based on the lower monthly payments, so qualification is easier. However, when the interest-only period ends, refinancing may be necessary, especially if the payment increase is unaffordable. This setup also gives you the chance to invest your potential savings elsewhere while still benefiting from homeownership’s tax advantages and property value appreciation.

Let’s take a $250,000 loan at a 6% interest rate:

• 30-Year Fixed-Rate Mortgage: A monthly payment of $1,499.

• 5-Year Interest-Only Mortgage: $1,250 for the first five years, saving you $249 per month. After five years, your payment would jump to $1,611, a $361 increase.

Qualification and the Need for Refinancing

Example Calculation

Short-Term Savings vs. Long-Term Costs

While interest-only mortgages provide short-term savings by lowering monthly payments, they can be more expensive in the long run. Many borrowers choose to refinance or pay off the loan early, helping to reduce the long-term costs.

Advantages for Borrowers with Irregular Incomes

For those with unpredictable incomes, like freelancers or commission-based workers, interest-only mortgages offer the flexibility to adjust payments. You can make extra principal payments during high-income months and revert to interest-only payments during slower months.

Bottom Line

Interest-only mortgages can be an appealing choice for borrowers who need lower initial payments or have inconsistent incomes. However, they come with the risk of significantly higher payments in the future and no equity building during the interest-only term.

Before opting for this type of mortgage, consider your long-term financial goals and potential income stability. You may also want to consult a financial advisor or check resources like the Consumer Financial Protection Bureau (CFPB) to help you determine if an interest-only mortgage is right for your situation.