How interest-only loans work
For the first years of an interest-only mortgage, often 10, each payment covers only the interest, so the balance doesn't go down. Afterwards the whole balance has to be repaid over the years that are left, so the payment rises sharply, higher than a regular loan's would have been from the start.
The CFPB describes the choices when the interest-only period ends: pay off the balance, refinance if you can, or start paying principal and interest at a higher monthly amount. This calculator shows the third path: the loan simply carries on and starts to amortize.
How the calculator works it out
During the interest-only years, each monthly payment is simply the interest on the full balance:
interest-only payment = balance × yearly rate ÷ 12
When that period ends, the balance is still what you borrowed (less any extra principal you chose to pay). It is then repaid with an ordinary level payment over the months that remain, so part of every payment now reduces the balance. That's what it means for the loan to amortize:
M = P × r ÷ (1 − (1 + r)−n)
where P is the balance at that point, r the monthly rate and n the payments left. On a 30-year loan with 10 interest-only years, n is 240, not 360. Fitting the same balance into two thirds of the time is what drives the jump. Every figure is worked in whole cents, as described on how we calculate.
Example: 10 interest-only years
$320,000 at 6.5% with 10 interest-only years costs $1,733.33 a month for those 10 years, then $2,385.83 a month for the next 20. A regular 30-year loan at the same rate would be $2,022.62 throughout. Over the loan the interest-only version costs about $52,000 more in interest ($460,600 against $408,140), because the balance stays at its highest for a decade.
Look at the first 10 years on their own. The interest-only payment is about $289 a month lower, but after 120 payments you still owe the full $320,000. The regular loan would have paid it down to $271,283.24 by then, about $48,700 of principal. In year 11 the payment rises by $652.50 a month, about 38%.
Example: a shorter interest-only period
The same $320,000 loan at 6.5% with only 5 interest-only years starts at the same $1,733.33, then rises to $2,160.66 for the remaining 25 years. Total interest is about $432,200: roughly $28,400 less than with 10 interest-only years, and about $24,000 more than the regular loan. The jump is smaller because the balance is repaid over 300 months instead of 240.
The pattern holds in general: the longer you pay only interest, the bigger the later payment and the more interest you pay in total, at the same rate.
Paying down principal anyway
Nothing stops you paying principal during the interest-only years. Add an extra amount every month above, or put a lump sum on any payment in the schedule, and see how much it lowers the payment when the loan starts to amortize. For example, on the 10-year interest-only loan above:
- $200 extra every month brings the balance down to $296,000 by the end of year 10, so the amortizing payment is $2,206.90 instead of $2,385.83. Kept up for the whole loan, it ends 36 payments early and saves about $67,500 in interest.
- A single $20,000 lump sum on payment 60 lowers the interest-only payment from then on (less balance means less interest), makes the amortizing payment $2,236.72, and saves about $22,300 in interest.
The extra payment calculator and payoff calculator can help you pick an amount.
Pitfalls and things to check
- Budget for the later payment, not the first. The CFPB warns not to count on selling or refinancing when the payment rises, because your home's value or your finances could change.
- No equity from payments. During the interest-only years, only price changes and any extra principal build equity. If prices fall, you could owe more than the home is worth.
- Fixed rate assumed. The calculator keeps the rate the same throughout. Some interest-only loans also have an adjustable rate; if yours does, the later payment could be higher still. The ARM calculator shows how rate resets work.
- Not a Qualified Mortgage. A loan with an interest-only period can't be a Qualified Mortgage, the category of loans with extra federal protections, so read the terms carefully.
- Tax, insurance and fees are extra. Add property tax and insurance in the form for the full monthly cost, and check your Loan Estimate for your loan's exact terms.
Common questions
How is an interest-only payment calculated?
Multiply the balance by the yearly rate and divide by 12. $320,000 at 6.5% is $1,733.33 a month.
What happens when the interest-only period ends?
The loan starts to amortize: the full balance is repaid over the years left, so the payment rises. In the 10-year example it goes from $1,733.33 to $2,385.83.
Does an interest-only loan cost more in total?
At the same rate, yes, because you owe more for longer. In the example it's about $52,000 more interest than a regular 30-year loan. Paying principal early narrows the gap.
Can I pay principal during the interest-only period?
Check your loan terms, but usually yes. Any principal you pay lowers the interest-only payments that follow and the amortizing payment later.
Can I refinance before the payment goes up?
You may be able to, but it isn't guaranteed; it depends on rates, your home's value and your finances at the time. The refinance calculator shows whether a new loan would pay off.
Is interest-only the same as a lower payment on a longer loan?
No. A 40-year loan still repays some principal every month. An interest-only loan repays none until the period ends. To compare the two structures directly, use the loan comparison.