How Do Interest-Only Mortgages Work?


Interest-only mortgages have more affordable monthly payments at first. That hurts homeowners who plan to sell the house before the loan converts. In 2006, when the housing boom ended, many homeowners weren’t able to sell because the mortgage was worth more than the house. The bank would only offer a refinance on the new, lower equity value.

Interest-only loans: What you need to know

For example, if you take out a “7/1 ARM”, it means your introductory period of interest-only payments lasts seven years, and then your interest rate will adjust once a year. Interest-only loans can be a useful financial tool for some borrowers, offering lower initial payments and flexibility in managing their finances. However, they also come with risks such as higher interest rates, payment shock, and limited equity buildup. It’s essential to carefully weigh the pros and cons and consider your unique financial situation before deciding if an interest-only loan is right for you. Based on the same 30-year loan for $100,000 at an interest rate of 5%, the monthly payment would be $416.67 (lower than the amortized payment of $536.82). These home loans are usually structured as adjustable-rate mortgages and frequently have terms of up to 10 years.

Should you borrow an interest-only mortgage?

But you’ll pay more in overall interest — plus, since interest-only loans aren’t qualified mortgages, there can be stricter requirements to qualify. Interest-only home loans require a smaller initial monthly payment that covers only the interest portion of the mortgage. Each monthly payment covers a portion of the principal and interest. 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. Interest-only payments may be made for a specified time period, may be given as an option, or may last throughout the duration of the loan.

You’re now leaving Chase

Mortgages are long-term commitments, and they don’t just affect your monthly budget — they can also influence your financial planning, investment strategies and overall lifestyle. An interest-only mortgage may seem attractive because of lower initial payments, but it also comes with potential risks and challenges. Considering both aspects gives you a more comprehensive acc 560 wk 2 quiz 1 all possible questions by carolrlangston understanding, and you’ll be more likely to make an informed decision that aligns with your financial goals and circumstances. Once the interest-only phase ends, you enter the principal repayment period, and the loan turns into a more traditional mortgage. Monthly payments increase, but they now go towards the principal and interest, allowing you to build equity.

Who Is Best Suited For an Interest-only Mortgage

Because rates are so high right now, this can save you money in home loan interest down the road when interest rates cool. Alternatively, if the housing market goes down during your interest-only period and you try to sell your house without paying off any of your principal, you may actually owe the bank money at the time of sale. Requirements vary, but even the best mortgage lenders typically require good or excellent credit. Most also require a larger down payment than you’d need for a traditional mortgage.

How Much Do They Cost?

By doing so, you postpone your principal payments until you have sold the renovated house, freeing up front-end cash to make said renovations. Since your loan balance won’t have gone down during the interest-only period, you’ll have a shorter time to pay it off, and your payments will be higher. For example, say you pay only interest for the first 10 years and your loan is a 30-year fixed-rate loan. You’ll pay down your principal balance for the last 20 years of your loan. Your payments will be higher because you’ll have 20 years to pay off the full balance, rather than 30 years. You can use our mortgage calculator to play around with the numbers and see what your payments might be.

Interest-only loans represent a somewhat higher risk for lenders, and therefore are subject to a slightly higher interest rate. The borrower may find themselves unable to afford the higher regularly amortized payments at the end of the interest-only period, unable to refinance due to lack of equity, and unable to sell if demand for housing has weakened. The best type of mortgage payment depends on your financial goals and objectives. If you’re looking to pay off your loan as quickly as possible—and save money on interest in the long run—then an amortized payment is the way to go. An interest-only payment may be better if you prefer to keep your monthly payments low.Keep in mind that with an interest-only payment, you’re not making any progress towards paying off the principal balance of your loan.

The most obvious benefit of an interest-only mortgage is that monthly payments are initially considerably lower than of typical loans. These loans allow the borrower to make larger purchases that they would otherwise only be able to afford a few years down. Thus, interest-only loans might be a wise investment if you are expecting a significant income boost in the coming months and years.

During her ownership, she will make lower interest-only payments, keeping her costs down until she sells the property for a higher price. After five years, Corrine’s interest-only period ends, and her monthly payments will begin covering the principal and the remaining interest. From that point forward, she must pay $1,754 each month for the remainder of her loan.

Conventional fixed-rate mortgages typically come in 15- or 30-year terms. However, its main drawback is that rates tend to be higher than with adjustable rate mortgages. The appeal of an interest-only mortgage is the lower initial payment, which you can stick with for as long as ten years before making any payments towards the principal.

This means it’s not a big deal if it takes a long time to build equity, and their income could increase over the years, making it easier to afford the larger monthly payments when the interest-only period ends. 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. 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. Refinance your existing mortgage to lower your monthly payments, pay off your loan sooner, or access cash for a large purchase.

Remember, these scenarios are examples and might not reflect every situation. It’s best to consider your personal financial circumstances and consult with a financial advisor before making a decision. Our suite of security features can help you protect your info, money and give you peace of mind.

This type of mortgage can help you more easily afford the payments in the short term — but not without some drawbacks. Don’t assume you’ll be able to sell your home or refinance your loan if your payment increases. The value of your property could decline or your financial condition could change. If you can’t afford the higher payments on today’s income, consider another loan. Interest-only loans are popular ways of borrowing money to buy an asset that is unlikely to depreciate much and which can be sold at the end of the loan to repay the capital.

You may need to reach out to multiple lending officers to find out if interest-only mortgages are available. An interest-only mortgage is a type of loan where you only need to pay the interest portion of your loan principal—at first. For questions or concerns, please contact Chase customer service or let us know at Chase complaints and feedback. All home lending products are subject to credit and property approval.

That number is $13,000 of interest, which is the annual amount of interest. Divide $13,000 by 12 months, which will equal your monthly interest payment or $1,083. Fleming says most are jumbo, variable-rate loans with a fixed period of five, seven, or 10 years. After a borrower takes out an interest-only loan, they are allotted an introductory grace period, during which they do not have to make payments on the principal of the loan. Instead, they only make interest payments throughout that set period.

  1. Below, we’ll discuss what an interest-only mortgage is, how to qualify for one, and some of their pros and cons so you can make the right choice for you.
  2. They pride themselves in using their skills and experience to create quality content that helps people save and spend efficiently.
  3. During her ownership, she will make lower interest-only payments, keeping her costs down until she sells the property for a higher price.

An interest-only home loan starts out with lower payments, so you might think it’s a good option for you. Below, we’ll discuss what an interest-only mortgage is, how to qualify for one, and some of their pros and cons so you can make the right choice for you. Alex and Emma are a young couple planning to live in a city for only a few years for work. They want to buy a house instead of renting, knowing they’ll likely sell it within five years. With an interest-only mortgage, they can take advantage of the lower payments during their stay and sell the house before the repayment period starts. Interest-only mortgages are not a one-size-fits-all solution, but they can offer unique advantages to some borrower profiles more than others.

When that doesn’t materialize, or if the current job disappears, the higher amount is a disaster. Others may plan on refinancing, but if interest rates rise, they can’t afford to refinance, either. Interest-only loans are also called exotic loans and exotic mortgages. Sometimes they are called subprime loans even though they weren’t only targeted to those with subprime credit scores. It’s impossible to calculate the actual lifetime cost of an adjustable-rate interest-only loan when you take it out because you can’t know in advance what the interest rate will reset to each year. There isn’t a way to ballpark the cost, either, Fleming says, though you can determine the lifetime interest rate cap and the floor from your contract.