What Is an Interest-Only Mortgage in Real Estate?
An interest-only mortgage is a home loan where the borrower pays only the interest for the first several years—usually 5 to 10. After that period ends, the loan converts to a standard principal-and-interest payment, which increases significantly.
💡 How an Interest-Only Mortgage Works
- Phase 1 — Interest-Only Period (5–10 years): Payments cover interest only; principal does not decrease.
- Phase 2 — Fully Amortizing: Payments jump when principal repayment begins.
- Typical structure: Fixed interest-only period → converts to fully amortizing loan.
- Most are ARMs: Many interest-only loans use an adjustable rate after the initial period.
During the interest-only phase, buyers enjoy a much lower monthly payment—but future payments will be higher.
🎯 Why Buyers Use Interest-Only Mortgages
- Lower initial monthly payment
- Short-term ownership or investment strategy
- Expecting higher income in future years
- Buying a home before selling their current property
- Planning to refinance before the payment increases
⚠️ Risks of Interest-Only Mortgages
- Payment shock: Payments increase sharply when principal is added.
- Slow equity growth: Principal remains unchanged during the interest-only period.
- Home value risk: If prices fall, borrowers may owe more than the home is worth.
- Harder qualification: Lenders require strong credit, stable income, and solid reserves.
📊 Example: Interest-Only vs Full Payment
Loan example: $400,000 at 6% interest
- Interest-only payment: ~$2,000/month
- After period ends: Payment may rise 40–70% once principal repayment begins