Amy Fontinelle has more than 15 years of experience covering personal finance, corporate finance and investing. For example, an interest-only mortgage could be a good fit for someone who earns large annual bonuses at work and uses those to pay down the principal. This website is using a security service to protect itself from online attacks. There are several actions that could trigger this block including submitting a certain word or phrase, a SQL command or malformed data.

• Monthly payments for interest-only loans tend to be lower than payments for standard loans.
• If you’re interested in keeping your month-to-month housing costs low, an interest-only loan may be a good option.
• This may influence which products we review and write about (and where those products appear on the site), but it in no way affects our recommendations or advice, which are grounded in thousands of hours of research.
• This shortens your loan term and allows you to pay off the loan balance faster.
• Now that you understand the potential difference in monthly charges for an interest-only loan, here is the main reason why you should consider one.

The benchmark rate changes as the market changes, but the margin is predetermined at the time you take out the loan. Some people think interest-only mortgages are inherently risky, but that’s not always the case. Learning the pros and cons of an interest-only mortgage will help illustrate this point.

Overall, if you’re a careful saver who’s in a position to take on a significant monthly payment in the long term, you might be a good candidate for an interest-only mortgage. Our goal is to give you the best advice to help you make smart personal finance decisions. We follow strict guidelines to ensure that our editorial content is not influenced by advertisers. Our editorial team receives no direct compensation from advertisers, and our content is thoroughly fact-checked to ensure accuracy. So, whether you’re reading an article or a review, you can trust that you’re getting credible and dependable information.

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Another reason why borrowers might take out an interest-only loan is to buy a vacation home, the idea being to sell their existing home in short order (3-5 years) and then move into their second home permanently. They would then use the sale of the family home to pay off the interest-only mortgage on the vacation home. Finally, just because interest-only loans enable you to buy a more expensive home does not mean that you can afford it. Be aware of the cost to own your home not just now but in the impending years after the interest rate adjusts. If you have any real concerns in this regard, you are probably looking at more house than you can afford. Her work has been published or syndicated on Forbes Advisor, SoFi, MSN and Nasdaq, among other media outlets.

With a 30-year fixed-rate interest-only loan, you might pay interest only for 10 years, then pay interest plus principal for the remaining 20 years. Since you aren’t paying down principal during the interest-only period, when the rate resets, your new interest payment is based on the entire loan amount. Keep in mind that the interest rate on an interest-only loan may be fixed or adjustable. If you choose an adjustable-rate, interest-only mortgage, you’re taking an additional risk because you don’t know what the interest rate will be when the interest-only period ends.

Discover Bank does not provide the products and services on the website. Please review the applicable privacy and security policies and terms and conditions for the website you are visiting. Discover Bank does not guarantee the accuracy of any financial tools that may be available on the website or their applicability to your circumstances. For personal advice regarding your financial situation, please consult with a financial advisor. One of the major risks in an interest-only loan is that the buyer may not be able to afford the higher payments when they take effect.

• Taking on mortgage debt on top of that isn’t an impossibility but might best be tackled with some help.
• If you can afford the payments and have the good credit required to refinance down the line before the rate adjusts higher, you should strongly consider an interest-only loan.
• In the example above, the monthly payment would be $1,266.71 for 360 payments, allowing for some variation for tax adjustments.
• Realized is a subsidiary of Realized Holdings, Inc. (“Realized Holdings”).
• These loans can also work for people who want flexibility and have the financial discipline to make periodic principal payments during the interest-only period.

Under the Dodd-Frank Act, a federal law passed in 2010 to protect against a repeat of the 2008 housing-market meltdown, buyers must meet certain standards to qualify. No-principal loans don’t fit the description, but lenders are willing to write interest-only if a borrower meets high standards. Rather than buy a conventional mortgage at a set rate, the clever consumer can either buy more house for the same monthly payment or pay what they want during the early phase of the loan. The first important aspect of this borrowing process requires understanding of how a mortgage works. For a conventional 30-year loan, consumers agree to borrow a set amount of money. In exchange, they agree to make monthly payments for a set period of time.

Buying a House

If you want to steer clear of this higher-risk form of home financing, you can explore other types of mortgages. Many adjustable-rate mortgages also have a long, low-interest introductory rate period — and, since the payments include some principal, you’ll be building equity during it. During the interest-only period, if you don’t make additional principal payments, you don’t earn any home equity. If you ever need cash, you won’t qualify for a home equity loan until you pay down a significant portion of the principal. An remote bookkeeping services will help you understand how this type of mortgage works. Say you bought a home for $200,000 and agreed to a 40-year interest-only loan with a 10-year interest only period.

Different Types of Mortgage Loans for Buyers and Refinancers

Online loans refer to loans that are received from a digital platform or app instead of a traditional bank. People may apply for online loans to quickly access a lump sum of funds and manage their financing from their mobile devices. From covering medical bills to paying for home renovations to even purchasing travel, online loans may be available to help individuals split large payments into smaller installments. Financial engineers, such as Wall Street dealers, frequently strip and restructure bond payments in an effort to earn arbitrage profits. For example, the periodic payments of several bonds can be stripped to form synthetic zero-coupon bonds. Zero-coupon Treasury strips are an important building block in many financial calculations and bond valuations.

Affordability

As rising interest rates make home loans more expensive, an interest-only mortgage might look like a good way to lower your monthly payments. Many borrowers plan to sell or refinance before the interest-only period ends. Requirements for an FHA loan are much looser than those of a conventional loan.

The process of separating the principal and interest on a debt obligation is known as stripping. A mortgage-backed security (MBS) that goes through this process—separating the interest and principal payment streams—is referred to as stripped MBS. Financial professionals have so much to offer in that regard, helping home buyers, especially first-time home buyers, navigate their finances and find the right mortgage for them.

What Happens at the End of the Interest-Only Period?

For example, investors may use cash savings to invest in equities until principal payments are required; this may result in higher-than-usual capital gains or losses. The interest rate may increase and the monthly payment must also cover some of the principal. Some interest-only mortgages require the borrower to pay off the entire balance after the introductory period. At the end of the initial period, borrowers must repay the principal either in one balloon payment at a set date, which can be very large, or in monthly payments (that also include interest) for the remainder of the term.

Interest Rate Considerations

Robert Shaw writes about finding ways to solve financial problems like keeping up with mortgage payments, paying off credit card debt and avoiding bankruptcy for Debt.org. During his 45-year career in journalism, Robert was a columnist for the Cleveland Plain Dealer before transitioning to television sports commentary at WKYC. Some of the financial institutions such as banks, online lenders and credit unions that offer conventional mortgages also offer interest-only mortgages.