Interest-only Mortgage Calculator
Calculate Your Monthly Mortgage Payments
The first calculator is a basic tool which shows monthly principal and interest payments and presumes the same interest rate for both loans. The calculator in the second tab allows you to set separate interest rates for each loan type and also allows you to input other estimated costs associated with homeownership including PMI, homeowners insurance, property taxes and HOA fees.
Current San Diego mortgage rates are published under the calculator in an interactive table which allows you to quickly compare loan payments for multiple loan types using real market data.
Thinking about getting an interest-only home loan? Use this free interest-only mortgage calculator to estimate your monthly loan payments for IO and amortizing payments side-by-side.
|Your Interest-Only Adjustable-Rate Mortgage Payment Details|
$975.00Interest Only Payment
$1,317.38Fully Amortized Payment
Current Mortgage Rates for a $260,000 5/1 Interest-Only ARM Home Loan
The following table highlights locally available current mortgage rates. By default they display 5-year IO ARM loans, but you can select other options using the "Products" drop down menu. Purchase rates are shown by default with refinancing offers available under the "refinance" tab.
The FRM and traditional hybrid ARM loan markets are much more liquid than interest-only loans. If no IO loans show below then consider looking at the 3/1 ARMs to see the options available across the network which have the lowest upfront monthly payments.
Re-Assessing the Interest-Only Mortgage and Its Applications
On the surface, it’s very tempting to get an interest-only mortgage. It seems cheaper than other home loans and easier to qualify for. The lower monthly payments make it a practical option for an already tight budget. But think again. Interest-only mortgages actually become pricier later down the line.
Since the 2000s, this option has fallen out of favor due to its association with the Mortgage Crisis. At the same time, there’s more to this option than meets the eye. Despite its shady reputation, these mortgages can be a viable option for some home buyers. For certain people, an interest-only mortgage may indeed be a good way to save money.
The Fundamentals of Interest-Only Mortgages
Most conventional mortgage payments consist of two parts: principal payments and interest payments. Taken together, they are known as your monthly P + I payment. Principal payments go toward paying off the amount you borrowed. Interest payments represent the fee you pay the lender for using their money. You pay these amounts through the entire amortization period of the mortgage.
In an interest-only mortgage, you only pay for the interest of your loan. This interest-only period lasts between three to ten years. It essentially defers principal payments on your mortgage. Because you only cover interest, the payments during this period are much lower. However, this period is temporary. After it lapses, you must make regular principal and interest payments.
You have the option to revert to a standard amortizing mortgage. This leads to much higher monthly payments for the remaining term. The other option is to pay off your whole balance with a lump sum. This is called a balloon payment.
Interest-only Mortgages Come in 3 Variants
- 30-year fixed-rate mortgages have an annual percentage rate (APR) that applies to the entire amortization period. They resemble the most common type of conventional mortgage available today. The interest-period period of a fixed-rate mortgage lasts for 10 years.
- Hybrid adjustable-rate mortgages (ARMs) have APRs that change according to an index rate. Unlike most ARMs, hybrids have fixed-rate periods that last several years before it begins to adjust. Your interest-only payments often last throughout the fixed-rate period.
- Payment-option ARMs, as the name suggests, give you options on how you can make your payments. You can pay a standard or minimum payment, depending on how much you can afford at that time. This can go on for several years. However, be forewarned. The skipped interest payments will be added to your principal balance.
On the whole, ARMs are not as popular with homebuyers as 30-year fixed-rate mortgages. Interest-only ARMs in particular are seen as especially risky. Ideally, ARMs are for people who do not plan on living in the same house for more than 30 years. These are often chosen by buyers looking for a starter home, or people who think they might need to move in a couple of years.
An ARM often comes with an introductory discounted rate. In ordinary circumstances, this can be much lower than those of fixed-rate mortgages. Once it lapses, your rate begins to adjust according to the referenced index rate. This can apply between a few months to a year in standard ARMs. Hybrid ARMs, meanwhile, have fixed-rate periods that can last for several years. Most come in denominations of three, five, seven, and ten years.
A hybrid ARM’s fixed-rate period and adjustment are expressed in fraction form. The first number represents the number of years the fixed-rate period applies. The second represents the frequency (in years) that the mortgage adjusts its APR afterward. Interest-only hybrid ARMs come in three common terms: 5/1, 7/1, and 10/1 ARMs. For example, if you take a 5/1 ARM, your rate remains fixed for the first five years of the loan. After the introductory period, the rate adjusts once a year for the rest of the term.
Note that the changing interest rate means you must be prepared for higher payments when market rates rise. For this reason, many ARM borrowers eventually refinance into a fixed-rate mortgage to avoid increasing monthly payments. But when market rates are low, ARM borrowers can take advantage of affordable monthly payments on their mortgage.
Some interest-only mortgages demand a balloon payment at the end of their term. Mortgages with balloon payments used to be common in the United States before the Great Depression. Today, however, they are rare and are heavily regulated. These are only allowed under specific circumstances outlined by Regulation Z of the Truth in Lending Act. Lenders must only grant balloon-payment mortgages according to stringent affordability guidelines.
A payment-option ARM lets homeowners pay what they can during their interest-only period. These mortgages have three payment options. The first is to pay the standard interest payment. The second includes the standard plus extra payment. Payments made on top of the interest goes toward lowering your mortgage principal. The third is a fixed minimum payment. This is the basic payment expected from your mortgage. You can elect to pay this minimum amount if you choose to.
If you’re running short on cash, you can choose the fixed minimum payment. This can be very convenient, especially in an emergency situation. If your house needed dire repairs, for instance, you could pay only the minimum so you can focus on construction costs. But with convenience comes risks. These missed interest payments are added to your mortgage’s principal.
Beware of Negative Amortization
Paying only the minimum puts your mortgage in a negative amortization. When this occurs, you might end up owing more money than your house is worth. This can become problematic because selling your house will be insufficient to cover the cost of your mortgage. Lenders also put an upper limit to negative amortization, which is usually 125 percent of your home’s purchase price. Once that happens, you must start making P + I payments.
Many ARMs have caps that put a limit to how high or low your APR can go. Lenders recalculate payment-option mortgages over time, usually around every five years. During this time, your new interest rate may be higher than the cap allows. This can make payment shock much more difficult to endure.
A conventional mortgage calculates your interest payments based on your remaining principal balance. At first, much of your monthly payment will go toward paying the interest you owe. The rest go toward paying your interest balance. Over time, your interest payment shrinks as you pay off more of your mortgage.
Let’s see this in action. Suppose you bought a house worth $300,000 on a 30-year fixed-rate mortgage. You pay a 20 percent down payment to avoid private mortgage insurance. This brings down your loan amount to $240,000. Your lender gives you an annual percentage rate of 2.8 percent. We’ll calculate your monthly P + I using our simple mortgage calculator.
30-Year Fixed-Rate Mortgage
Home Value: $300,000.00
Down Payment: $60,000.00
Loan Amount: $240,000.00
In our example, your monthly P + I would be $986.15. In a conventional mortgage, your monthly payment goes toward your interest first. Your monthly interest will vary through the life of your mortgage. This is expressed in the formula below:
I = Bi
I = Your monthly interest cost
B = Your principal balance
i = Your monthly APR
The monthly APR is your current APR divided by 12. In our example, your first month’s interest payment is as follows:
I = $240,000 x (0.028 / 12)
I = $240,000 x 0.0023
I = $560.00
|Fully Amortized Payment (P + I)||$986.15|
|Monthly Difference (Principal Payment)||$426.15|
If you take out an interest-only mortgage with similar terms, you only need to pay $560. On the surface, that seems like a lot of money saved. That’s nearly half of the amount your P + I would have been. The elephant in the living room, of course, is that none of those payments go toward your principal. The trouble is that you’re not building any equity past your down payment.
Your principal payment is essential for recalculating your monthly interest payment. As your principal shrinks, so does your interest. In our example, you paid $426.15 as principal on your mortgage’s first month. Your new balance will be $239,573.85.
Let’s see how this goes for the next 12 months:
Notice that your interest payments slowly go down. In a conventional fixed-rate mortgage, most of the money at first goes toward interest. Over time, more of your money goes toward principal payments. You can even speed up this process by paying extra toward your mortgage. This also helps you reduce the amount of money you pay in interest.
This isn’t the case with an interest-only mortgage. In that same ten years, your principal balance remains at $240,000 unless you decided to pay extra. In that time, you would’ve paid $67,200 in interest only. In essence, you will be paying P + I payments for a 20-year mortgage for the rest of your term. Let’s look at how much more you would have spent at that time:
|Loan Details||Interest-Only 30-Year Fixed-Rate Mortgage||30-Year Fixed-Rate Mortgage|
|Total Interest Payments||$140,912.16||$115,012.80|
All in all, you would’ve paid $25,899.36 more with an interest-only mortgage compared to a fixed-rate loan. And this is already assuming that your mortgage has a fixed APR. Avoid an interest-only loan if you want to save money on a long-term mortgage.
The Challenges of an Interest-Only Mortgage
At the end of the interest-only period, you revert to a regular mortgage with a P + I payment. This can cause what’s known as payment shock. If you weren’t ready for it, your new monthly payment can leave your finances in disarray. If your mortgage was a hybrid ARM, your payments may even skyrocket if the index rate rose. If you don’t intend to sell your house, it’s ideal to refinance into a fixed-rate mortgage if you are able.
To allay some of the shock, you could try lowering your principal balance. Paying extra toward your mortgage can keep your new P + I payments down. You may also buy yourself some time by applying for another interest-only period. However, this is an expensive proposition as you’re only delaying the time it takes to pay off your principal. You also end up paying more interest the longer you pay off your debt. This can be useful if you’re planning to sell your home. That way, you can pay off your balance with the proceeds of your home. But if you’re staying long-term in your house, it’s actually a costly arrangement.
Interest-only mortgages isn’t for everyone. Their long-term costs and consequences make them more expensive and risky in the long run. In 2020, some of the biggest lenders have restricted interest-only mortgages to jumbo loans. These large mortgages, meant for expensive properties, are much harder to apply for.
An interest-only mortgage sounds tempting if you expect to build more income in the future. They might also seem ideal if you have a lot of savings but have an irregular income stream. But unless you can afford higher payments in the future, this loan might not be right for you.
A Poster Child For Fiscal Irresponsibility
The prevalence of interest-only mortgages is among the factors behind the Subprime Mortgage Crisis of the mid-2000s. Unscrupulous lenders misled hundreds of thousands of prospective homeowners into taking these mortgages. Wooed by the prospect of low monthly payments, these buyers were taken aback by payment shock. Many of these people lost their homes to foreclosures.
A lot of people were left holding the bag when they applied for interest-only mortgages. Many of these buyers defaulted during the Subprime Mortgage Crisis of the late 2000s. Predatory lenders misled buyers into looking only at the advertised monthly payments. Because of the housing crash, these homeowners couldn’t sell their homes. Many were stuck with mortgages they couldn’t afford.
The Interest-Only Advantage
The interest-only mortgage is not meant for general purpose home buyers. People who want to settle down long-term should instead choose a conventional fully amortizing mortgage. But if you’re not building any equity with an interest-only mortgage, what is it even good for? The answer could surprise you.
Those who don’t want to stay in place can use an interest-only mortgage to their advantage. Buyers who sell their homes after a few years have no pressing need for home equity. By choosing this option, they cut down on their monthly bills. Once they sell their home, they can clear off their mortgage balance.
Among these are property investors. Many investors make money from renovating and selling fixer-upper houses. This is known as fixing and flipping. To maximize the profits they make from reselling the house, investors must buy low and sell high. Thus, a house flipper must keep all attendant costs as low as possible.
The smaller monthly payments offered by interest-only mortgages are ideal for this purpose. House flippers can expect to sell their properties within at least a year or less. By paying only interest, they cut down their expenses they accrue before selling the property.
This isn’t the only time where an interest-only ARM can work for you. There are plenty of instances where you don’t need a standard fixed-rate mortgage. These often revolve around selling an older property. During a divorce, for instance, you may want to buy out your partner’s share of conjugal property and then sell it. You might want to retire elsewhere and buy a second home in anticipation. In these situations, an interest-only mortgage is a quick and inexpensive solution.
The following table summarizes the pros and cons of an interest-only mortgage:
|You only need to make interest payments during the first few years of the loan (interest-only period).||Deferring principal payments means you do not build home equity right away.|
|Your monthly mortgage payments will be cheaper.||While you have time to save, you may also be tempted to spend for other costs.|
|The low monthly payments allow you to qualify for a larger loan amount.||After the interest-only period, your monthly payments will increase significantly.|
|The low monthly payments may allow you to prepay your mortgage.||If you make extra payments toward the principal, you might be charged prepayment penalty fees.|
|During the interest-only period, you can save and invest money in other worthwhile ventures.||If market rates continue to increase, your payments will become unaffordable.|
|Monthly payments for the interest-only period qualifies as tax deductible.||If you have trouble meeting expensive payments, it puts your home at risk of foreclosure.|
|Your total costs will be lower if you choose to sell your home at a later date.||Your home sale may not be enough to cover your mortgage balance if your loan faces negative amortization.|
Mortgages charge you for paying more than your standard payment. These prepayment penalties protect the lender. They make much of the profit from mortgages during the early years of a mortgage. Early repayment reduces the interest they earn and cuts down on their profits. By putting up these penalties, they discourage you from making larger payments early.
Another way to weather out prepayment penalties is to wait them out. Since 2014, regulations have limited prepayment penalties for the first three years after the consummation of your mortgage. However, you may plan on disposing your home long before that, especially if you plan to flip. Shop around for mortgages that don’t have penalties attached to them.
Qualifying for an Interest-Only Mortgage
It takes more than a good enough credit score to qualify for an interest-only mortgage. Since the 2000s, these mortgages were subject to new restrictions. They can no longer be used to finance entry-level home buyers.
The most important of these qualifications is proof of income. To maximize your chance of approval, you must provide ample documentation of your monthly cash flow. This assures lenders that you can afford payments once your interest-only period lapses. It also means you would not be caught in payment shock once it happens.
In addition, you must also have ample cash on hand. Proving that you have enough savings is not the only requirement. You must also make a down payment far larger than the minimum. Borrowers must also be prepared to pay 20 to 30 percent of their property’s value up front. Lenders may even demand a down payment of 50 percent for Interest-only jumbo loans.
Assess your situation carefully before choosing this option. The biggest challenge of interest-only mortgages is dealing with the principal payments once they’re due. Will you refinance or pay the balloon payment? Will you be able to afford it? Answering these questions is key to knowing if this is the right mortgage for you.
Interest-only mortgages can be an excellent tool for some buyers. This option is ideal for homeowners who do not plan on holding onto their properties in the long term. Even if you qualify for an interest-only mortgage, it will still come with great risk. Expect some of these setbacks and prepare for them.
Paying off an interest-only mortgage to maximize your savings is a race against time. You often must sell your property before the interest-only period lapses. There is a good chance that the selling process might not go fast enough. This is especially true if the real estate markets slow down in the interim. Be prepared to pay for your mortgage far longer than you expect.
Set aside extra money for future payments well in advance. This covers your costs if it takes longer to sell off your house and will help reduce payment shock. If you plan to stay, adjust your budgets before your interest-only period lapses. This will help ease you into your new mortgage terms. Ideally, you should refinance into a fixed-rate loan for more stable payments if you plan to keep your home for the long-term.
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