Interest Only Mortgage Calculator
Determine your monthly mortgage payment during the initial interest only period and potential future monthly mortgage payments for an interest only mortgage (interest only ARM). An interest only mortgage typically converts into an amortizing mortgage, usually an ARM, following the initial interest only period of the loan, which is three, five, seven or ten years. Our interest only mortgage calculator also allows you to understand the worst case scenario for an interest only mortgage by showing what the monthly mortgage payment and total interest expense over the life of the mortgage would be if the interest rate reached its maximum level as soon as possible in the adjustable rate period
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What Borrowers Should Know About an Interest Only Mortgage
Interest Only Mortgage Basics
With an an interest only mortgage you pay only interest and no principal during the first three, five, seven or ten years of the loan, which is called the interest only period, and then loan converts into an amortizing mortgage and you pay both principal and interest for the remainder of the mortgage, which is called the adjustable rate period because your interest rate is subject to change. Interest only mortgages are often referred to as 3/1, 5/1, 7/1 or 10/1 Interest Only ARMs (IO ARMs) with the first number indicating the length of the interest only period and the second number indicating how frequently the interest rate can change during the adjustable rate period. For example, with a 5/1 IO ARM, you pay only interest at a fixed interest rate for the first five years of the loan and then you pay both interest and principal plus your mortgage rate is subject to change and potentially increase on an annual basis for the remaining 25 years of the mortgage.
Interest Rate for an Interest Only Mortgage
The interest rate for an interest only mortgage during the interest only period is set by the lender based on market conditions and negotiations with the borrower. The interest only period interest rate is usually less than the rate for a 30 year fixed rate mortgage but higher than the rate for a comparable adjustable rate mortgage (ARM). The interest rate during the adjustable rate period is called the fully-index rate and is determined by adding the index to the margin. The margin is a set interest rate, usually between between 2.0% and 3.0%, that does not change over the course of your mortgage. The index is an underlying interest rate, such as LIBOR or the treasury rate, that fluctuates based on economic factors. Because you add the index to the margin to determine your mortgage rate, if the index increases, your mortgage rate increases but if the index decreases, your rate goes down. If the fully-indexed rate increases, your mortgage payment increases as well. Additionally, when your mortgage converts from an interest only loan to an amortizing loan, your mortgage payment typically increases because you start paying both principal and interest plus your interest rate can increase which would cause your payment to increase even more.
Benefits of an Interest Only Mortgage
Benefits of an interest only mortgage include a lower initial monthly mortgage payment as compared to a fixed rate mortgage or adjustable rate mortgage. The lower monthly mortgage payment typically means that you can afford a larger mortgage amount with an interest only loan. Additionally, interest only loans offer borrowers the flexibility to pay down their mortgage balance when they want to. Borrowers can pay down their mortgage balance by any amount at any time over the course of the loan which is especially beneficial to borrowers who generate a significant portion of their income from a bonus. Interest only mortgages can also be a good option for borrowers in a high interest rate environment. In that scenario you pay a lower monthly payment initially and then you also benefit when your interest rate declines in the future. Predicting interest rates is highly challenging and exposes borrowers to significant risk.
Negatives of an Interest Only Mortgage
Negatives of an interest only mortgage include the possibility that your monthly payment and interest rate jump in the future. When your mortgage converts from an interest only loan to an amortizing loan, your mortgage payment typically increases because you start paying both principal and interest plus your interest rate can increase which would cause your payment to increase even more. With some interest only mortgages your mortgage rate can increase by 50% or more at any adjustment period which causes your monthly payment to increase significantly. In general, interest only mortgages are better suited for borrowers with a higher risk tolerance or who are going to sell their homes before the end of the interest only period. Borrowers who value certainty and peace of mind should avoid the potential payment shock associated with an interest only mortgage.
More FREEandCLEAR Mortgage Resources
Review our comprehensive explanation of how an interest only mortgage works including key program terminology, reasons to select an interest only mortgage and informative examples
Understand the key risks of an interest only mortgage including potential payment shock when borrowers are required to start paying both principal and interest
Review interest only mortgage rates in your area based on interest only period rate, credit score and other inputs. Comparing interest only mortgage rates from multiple lenders is the best way to find the mortgage with the lowest rate and fees
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