Interest-only loans: Lower payments, more flexibility

What is an interest-only mortgage?

With an interest-only mortgage, you pay only the interest portion of your loan for a set period, typically 5-10 years. During this time, your monthly payment is lower because you're not paying down the principal balance.

After the interest-only period ends, the loan converts to a fully amortizing mortgage. At that point, your payments increase because you're paying both principal and interest over the remaining loan term.

How it works

Let's look at a $500,000 loan at 7% interest:

During interest-only period:

• Monthly payment: ~$2,917 (interest only)

After conversion to 30-year amortizing:

• Monthly payment: ~$3,327 (principal + interest)

That's a difference of about $410 per month during the interest-only period. Over 10 years, that's nearly $50,000 in cash flow you could use for other purposes.

Who benefits from interest-only loans?

Interest-only mortgages work well for specific situations:

High-income professionals with variable compensation If a significant portion of your income comes from bonuses, commissions, or equity, interest-only payments provide flexibility. Make minimum payments during lean months, pay down principal when bonuses arrive.

Real estate investors Lower payments improve cash flow on investment properties. Many investors use interest-only loans to maximize returns and reinvest the savings into additional properties.

Business owners When capital is better deployed in your business than in home equity, interest-only loans free up cash for growth opportunities.

Short-term ownership plans If you're confident you'll sell or refinance before the interest-only period ends, you can benefit from lower payments without worrying about the payment increase.

Those expecting significant income growth Medical residents, associates at law firms, and others with clear paths to higher income may prefer lower payments now with plans to pay more later.

Interest-only loan options

Jumbo interest-only Most interest-only loans are jumbo products (above conforming loan limits). These are common for high-net-worth borrowers.

ARM with interest-only Adjustable-rate mortgages often offer interest-only options during the initial fixed period. A 7/1 ARM with interest-only might have 7 years of interest-only payments before adjusting.

HELOC Home equity lines of credit typically have interest-only payments during the draw period (usually 10 years), then convert to amortizing payments during the repayment period.

The trade-offs

Interest-only loans have real advantages, but understand what you're giving up:

No equity build during interest-only period Your balance stays the same. You only build equity through home appreciation, not mortgage paydown.

Payment shock risk When the interest-only period ends, your payment increases significantly. Make sure you can handle the higher payment.

Potentially higher rates Interest-only loans sometimes carry slightly higher interest rates than fully amortizing options.

Less product availability Interest-only options are primarily available for jumbo loans and investment properties. Conventional conforming loans rarely offer this feature.

Managing an interest-only loan responsibly

If you choose an interest-only loan, consider these strategies:

Make principal payments when you can Nothing stops you from paying extra toward principal. The interest-only feature gives you flexibility, not an obligation to avoid principal.

Build reserves Use some of your payment savings to build cash reserves for when payments increase.

Have an exit strategy Know how you'll handle the payment increase, whether through refinancing, selling, or simply paying the higher amount.

Track your timeline Don't be surprised by the conversion date. Mark it on your calendar years in advance.

Qualification requirements

Interest-only loans typically require:

• Higher credit scores: Usually 700+ minimum, 720+ preferred
• Lower debt-to-income ratios: Lenders often qualify you at the fully amortizing payment, not the interest-only payment
• Larger down payments: 20-25% or more is common
• Significant reserves: 6-12 months or more of payments in liquid assets

Is interest-only right for you?

Interest-only loans are tools, not automatically good or bad. They work well for financially sophisticated borrowers who understand the trade-offs and have a clear strategy.

They're not ideal if you're stretching to afford a home and hoping the lower payment makes it work. The payment increase when the interest-only period ends could put you in a difficult position.

Explore your options

If you're considering an interest-only mortgage, let's discuss whether it fits your situation and financial goals. Get pre-qualified to see what you qualify for, or schedule a call to talk through your options.