This calculator gives estimates for education and planning. It is not investment, tax or legal advice; for decisions about your own situation, talk to a qualified financial professional.
How an interest-only loan works
With an ordinary mortgage, each payment covers the interest and repays a little of the principal, so the balance falls to zero by the end. With an interest-only loan, the payments cover only the interest for a set period. The balance stays the same, and the principal must then be repaid in one lump sum, refinanced, or paid off with higher payments over the remaining term.
The formulas
- Monthly interest-only payment = loan amount × annual rate ÷ 12.
- Total interest = monthly payment × number of months.
- Amortizing payment, for comparison: P × i ÷ (1 − (1 + i)⁻ⁿ), with i the monthly rate and n the number of months.
- Monthly savings to rebuild the principal at a return j per month: P × j ÷ ((1 + j)ⁿ − 1).
Worked example
A $300,000 loan at 6% for 10 years:
- Interest-only payment: 300,000 × 0.06 ÷ 12 = $1,500 a month.
- Total interest over 10 years: $180,000, and the full $300,000 is still owed at the end.
- An amortizing loan at the same rate and term would cost $3,330.62 a month, with about $99,674 of interest in total.
- To have $300,000 ready after 10 years in an account earning 4%, you would need to save $2,037.35 a month. Interest plus savings comes to $3,537.35, more than the amortizing payment.
The comparison shows the catch: the lower payment is only lower because you are not repaying anything. As soon as you plan to repay the principal, you need a savings return above the loan rate to come out ahead.
When interest-only can make sense
- Investors who expect to sell the property or refinance before the end of the interest-only period and want to keep cash flow high.
- Borrowers with irregular income, such as commission or bonus earners, who make large principal payments when the money comes in.
- Construction and bridge loans, which are short and meant to be replaced by permanent financing.
The risks
- Payment shock: when a 10-year interest-only period ends on a 30-year loan, the principal must be repaid over the remaining 20 years, and the payment can jump by 40% or more.
- No equity from payments: if prices fall, you can owe more than the property is worth.
- Higher total cost: interest is charged on the full balance every month.
In the United States, interest-only mortgages do not meet the Qualified Mortgage rules of the Consumer Financial Protection Bureau, so they are usually non-QM loans with stricter requirements and higher rates.