Those with an interest only mortgage only pay the interest on the loan for a set period, typically the first 5 – 10 years of the loan.
A Interest only mortgage comes in two varieties: adjustable rate and fixed-rate. Fixed-rate interest-only options are rare. Usually, interest-only mortgages come baked into some type of adjustable-rate structure.
An important note: interest-only mortgages are a type of nonconforming mortgage, which means they’re hard to find and (usually) even harder to get. This is because only conforming mortgages can be insured, guaranteed, and backed by Fannie Mae and Freddie Mac, which is why interest-only options aren’t widely available.
How Does an Interest-Only Mortgage Work?
For the first 5 or 10 years of the loan, an Interest only mortgage is straightforward: the borrower pays only the interest due on the loan. For example, you have a 30-year interest-only mortgage on a $300,000 home with an initial interest-only term of 5 years. At an interest rate of 3.5%, you’ll pay $875 each month during the interest-only term. After the interest-only term expires, things get more expensive. In year six, the principal begins amortizing and the overall monthly payment on the loan increases substantially, because now you’re paying both interest and principal over a shorter length of time. Take our $300,000 example above: after the first five years, the monthly payment escalates to $1,500 because you are now paying interest and principal amortized over 25 years instead of 30.