Interest-Only Mortgages

With an interest-only mortgage, you can choose to pay only interest during the first first five, ten, or fifteen years of the loan. During this period, monthly payments are lower than those with a fully amortized loan, because the borrower is only paying back the interest portion.

After this initial interest-only period you still have the entire principal amount to pay off – at this point the principal is amortized over the remaining loan term. For example, with a 30-year mortgage that has a 10-year interest-only payment period, the principal will be amortized over the remaining 20 years of the loan. The shorter amortization period means the borrower will be required to make higher monthly payments in order to repay the full amount of the loan. From this point onwards monthly payments will include both principal and interest and will be higher than with a conventional mortgage.

Not all interest-only mortgages have a fixed interest rate. Some interest-only mortgages come with a higher interest rate after the interest-only period has expired. Others can ‘convert’ to an adjustable-rate mortgage (ARM) after the initial period, exposing the borrower to higher payments if rates have gone up during the interest period. Some allow the mortgagor to pay against the principal optionally if they so choose, reducing the overall cost of the loan.

Interest-only mortgages are becoming more popular with consumers because they are easier to qualify for, allow the borrower to afford a more expensive house and, at least initially, provide for lower monthly payments. But if you’re thinking of a mortgage with an interest-only feature, make sure you understand what your monthly carrying costs will be after the principal payments begin.