This could make it easier to achieve other financial goals or just lighten the load a bit. With lower initial monthly payments, interest-only mortgages provide financial flexibility that traditional mortgages may not offer. Let’s break down everything to know about interest-only mortgages and how they work.
Again, your monthly payment and total interest will change as the rate adjusts, but if your rate were to remain at 6%, you would pay $463,353 in interest. The big drawback of a hybrid mortgage is that once the interest rate converts to an adjustable rate, your payments can skyrocket. If you haven’t chosen your loan carefully, your payments could become unaffordable.
The information that we provide is from companies which Quicken Loans and its partners may receive compensation. This compensation may influence the selection, appearance, and order of appearance on this site. The information provided by Quicken Loans does not include all financial services companies or all of their available product and service offerings. Article content appears via license from original author or content owner, including Rocket Mortgage. Interest-only loans represent a somewhat higher risk for lenders, and therefore are often subject to a higher interest rate.
The risks and disadvantages of interest-only loans
- This means replacing the existing loan with a new one, ideally with better terms.
- They can be appealing for those seeking initial cash flow flexibility; however, they require careful planning to manage future higher payments.
- Because of this, getting an interest-only mortgage with plans to sell before the interest-only period ends is risky.
- On top of that, these loans often come with higher interest rates compared to traditional loans.
- You’ll probably need at least a 20% down payment to qualify for an interest-only loan.
Interest-only loans typically require a more nuanced underwriting process, especially when they fall under non-QM guidelines. Because borrowers are not paying down the principal during the initial period, lenders focus more heavily on the borrower’s ability to repay once the IO period ends. Your monthly payments increase to include both principal and interest, often calculated over the remaining loan term. With most loans, your monthly payments go toward both your interest costs and your loan balance. Over time, you keep up with interest charges and gradually eliminate the debt owed.
Investment and financial flexibility
During the initial interest-only period, you’re not building equity unless your home value goes up. That may sound sketchy but it’s actually a strategic move for people who expect their income to increase, plan to refinance, or don’t intend to stay in the home long-term. If you’re looking for lower monthly payments or a short-term living arrangement, this could be the right option for you. Keep in mind that payments towards your principal are inevitable down the line. Talk with a Home Lending Advisor to learn more about interest-only mortgages.
Other factors, such as our own proprietary website rules and whether a product is offered in your area or at your self-selected credit score range, can also impact how and where products appear on this site. While we strive to provide a wide range of offers, Bankrate does not include information about every financial or credit product or service. An interest-only mortgage requires payments just of the interest — the cost of borrowing money — during the first years of the loan. After the interest-only period, you can refinance or pay off the loan or start making monthly payments of both principal and interest. Borrowers have several options when the interest-only mortgage term ends.
The requirement for an interest-only loan is higher than a standard loan. Because interest-only loans come with higher risks, lenders often set stricter qualification requirements. To get approved, you’ll likely need a high credit score, strong income, and a solid repayment plan. Some lenders also require proof that you have a backup repayment strategy in place, such as investments or other assets that can cover the loan when needed. An interest-only loan is a type of loan where, for a set period, you only pay the interest on the amount you borrowed. Unlike traditional loans, where payments cover both interest and principal, this option allows lower payments at the beginning.
However, with an interest-only mortgage, borrowers only pay the interest on their home loan for a period that generally ranges from five to ten years. After this initial period has expired, payments are recalculated and borrowers begin paying down the principal amount. Interest-only loans offer lower initial payments and flexibility, making them attractive to certain borrowers.
An interest-only mortgage is a loan with scheduled payments that require you to pay only the interest for a specified amount of time. Interest-only loans can be a prudent personal finance strategy under certain circumstances, but they’re not a good idea for everyone. An interest-only mortgage can be beneficial if your annual income is unpredictable. Also, new homeowners can use the money they save in the first few years of their interest-only mortgage to make investments and pay off existing debts. You might be able to find a home loan with a lower interest rate which can make the shift less drastic, as you’ll be paying a better rate. You can use a comparison website to compare loans, and either ask your current lender to match it or consider switching home loans.
- At Griffin Funding, we’re happy to help you explore your options and determine if refinancing into an interest-only mortgage is the right fit for you.
- Bankrate has partnerships with issuers including, but not limited to, American Express, Bank of America, Capital One, Chase, Citi and Discover.
- Some lenders also require proof that you have a backup repayment strategy in place, such as investments or other assets that can cover the loan when needed.
- You can refinance after the interest-only period is over, but as in any refinance, you’ll need to receive a home appraisal and pay closing costs and fees, which can total 2 to 6 percent of the loan amount.
- In addition, once your interest-only mortgage rate begins to adjust, it’ll fluctuate with the broader market.
With an interest-only loan, your loan payments are only enough to cover the loan’s interest. But these mortgages have stricter qualifications than typical principal-and-interest loans, and they’re appropriate for only a narrow range of homeowning scenarios. She has covered personal finance topics for almost a decade and previously worked on NerdWallet’s banking and insurance teams, as well as doing a stint on the copy desk. The Experian Smart Money™ Debit Card is issued by Community Federal Savings Bank (CFSB), pursuant to a license from Mastercard International.
Others choose to sell the property or asset they purchased with the loan, hoping that its value has increased enough to cover what they owe. One of the biggest differences between interest-only loans and traditional loans is how payments are structured. With a traditional loan, you make payments that slowly reduce the total amount you owe, meaning your debt decreases over time. But with an interest-only loan, you’re only covering the cost of borrowing the money, so the principal remains the same.
Interest-only loans, especially adjustable-rate options, come with more uncertainty. If interest rates rise, payments can increase unexpectedly, adding financial stress. If you don’t actively save or make what is an interest only loan extra payments, you’ll still owe the full loan amount when the interest-only period ends.
During this initial term, you’re welcome to make payments towards the principal loan amount, but this isn’t required. If you can afford it, you might want to consider paying the principal on interest-only loan early because it can help reduce your debt. Interest rates on interest-only mortgages can be either fixed or variable. A fixed-rate loan offers predictable monthly payments, while a variable-rate loan’s interest rate fluctuates with market changes. Because interest-only loans don’t reduce the principal early on, borrowers end up paying more in interest over time.