Interest-Only Mortgage
An interest-only mortgage allows you to pay only the interest on your loan for an initial period (typically 5–10 years), resulting in lower payments during that time but no reduction in your principal balance. After the interest-only period ends, payments jump significantly as you begin repaying principal and interest over the remaining term.
On a $500,000 interest-only loan at 7%, your monthly payment during the interest-only period is $2,917 — compared to $3,327 for a standard principal-and-interest payment. You save $410/month initially, but you build no equity unless property values rise. When the interest-only period ends, your payment on the same 7% loan with 20 years remaining would be approximately $3,876/month — a $959 jump.
Interest-only loans make the most sense in specific scenarios: highly compensated borrowers with variable income who want maximum cash flow flexibility, investors who plan to sell before the I/O period ends, and buyers in rapidly appreciating markets who can sell before principal payments kick in. They are not recommended for buyers who can barely qualify — the payment shock when the I/O period ends can be unmanageable.
After the 2008 financial crisis, interest-only loans largely disappeared from the conforming market. They still exist in jumbo loans and portfolio products from banks. They typically require higher down payments (20–30%) and stronger credit (720+) than standard mortgages.
Key Takeaway
An interest-only mortgage allows you to pay only the interest on your loan for an initial period (typically 5–10 years), resulting in lower payments during that time but no reduction in your principal balance. After the interest-only period ends, payments jump significantly as you begin repaying principal and interest over the remaining term.
Related Terms
Frequently Asked Questions
Only through property appreciation. You build zero equity through payments during the interest-only period since no principal is being reduced.
Your payment increases significantly as you must now repay principal and interest over the remaining loan term, which is shorter than the original term.
Investors with short hold periods, high-income borrowers with variable compensation who want payment flexibility, or those with a specific plan to sell or refinance before the I/O period ends.
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