Some individuals take out personal loans with interest-only payments to manage expenses before their income increases. Businesses sometimes use interest-only loans to keep cash flow available while they invest in growth. Usually, interest-only loans are structured as a particular type of adjustable-rate mortgage (ARM), known as an interest-only ARM. You pay just the interest, at a fixed rate, for a certain number of years, known as the introductory period. After the introductory period ends, the borrower starts repaying both principal and interest, and the interest rate will start to vary.
Credit unions sometimes offer more flexible terms for their members, though availability varies. Private lenders may be easier to work with but often charge higher interest rates and fees. An interest-only loan can make sense if you expect your income to increase but need to keep your short-term housing costs low.
This means you’re not chipping away at the principal, which is what happens when paying off a principal-and-interest home loan. The difference between an interest-only loan and a principal and interest loan comes down to what the repayments are going towards. Our partners cannot pay us to guarantee favorable reviews of their products or services. We believe everyone should be able to make financial decisions with confidence. Yes, you can typically refinance an interest-only mortgage to a traditional mortgage or another loan type. Ultimately, deciding whether an interest-only mortgage is the right choice depends on your financial situation, risk tolerance, and investment strategy.
Applications for a mortgage to purchase a home last week were 6.6% lower from four weeks before, according to the Mortgage Bankers Association. CNBC’s Property Play with Diana Olick covers new and evolving opportunities for the real estate investor, delivered weekly to your inbox. “This was a pretty straightforward reaction to a hotly anticipated jobs report,” said Mortgage News Daily Chief Operating Officer Matt Graham. Weigh your financial goals carefully and consult an expert to determine if an interest-only mortgage is the right choice for you. At HomeLight, our vision is a world where every real estate transaction is simple, certain, and satisfying. If you like the idea of an interest-free home loan and you’re able to find and qualify for one — great!
Alternatives to Interest-Only Mortgages
It can be if you have a short-term plan or expect a major income increase. If you’ve ever looked at a mortgage calculator and thought, “There’s no way I’m ready for those payments,” you’re not alone. Enter interest-only mortgages – that financial life hack your conventional banker probably isn’t texting you about. Check with your lender about the rules for paying down your principal, as some loans won’t adjust the payment.
- When you’re ready to apply for the loan, shop carefully and get quotes from multiple lenders to find the best loan terms you can get.
- Just be sure to proceed with caution and carefully read through every document to ensure that you have a full understanding of the terms and conditions of the loan.
- If you don’t actively save or make extra payments, you’ll still owe the full loan amount when the interest-only period ends.
For example, if you take out a “7/1 ARM”, it means your introductory period of interest-only payments lasts seven years, and then your interest rate will adjust once a year. In an adjustable-rate interest-only mortgage (ARM), the interest rate can change periodically based on market conditions, leading to fluctuating monthly payments. In contrast, a fixed-rate interest-only mortgage maintains the same interest rate during the interest-only period, providing consistent payments. After this period, both types typically require payments on both principal and interest, with ARMs potentially adjusting rates at specified intervals.
The housing market may decline, for example, or your home might lose value for some other reason. Because of this, getting an interest-only mortgage with plans to sell before the interest-only period ends is risky. It takes a long time to build equity with an interest-only mortgage, because you won’t make any progress on the principal owed for several years. If you want homeownership to be a significant part of your financial portfolio, an interest-only mortgage isn’t a good tool to help you get there.
- The good news is that adjustable rates are starting lower than fixed rates right now.
- They are technically available from certain interest-only mortgage lenders, but they’re pretty rare.
- We analyze millions of home sales to find buyer’s agents who will show you the right home at the right price.
Choosing a mortgage term
Say you obtain a 30-year interest-only loan for $350,000, with an initial rate of 6.5 percent and an interest-only term of seven years. Even though you’re only required to pay the interest during the introductory period, you can still pay down the principal if you choose. You can refinance after the interest-only period is over, but as in any refinance, you’ll need to receive a home appraisal what is an interest only loan and pay closing costs and fees, which can total 2 to 6 percent of the loan amount. Your lender or insurer may use a different FICO® Score than FICO® Score 8, or another type of credit score altogether.
Put simply, this is a mortgage where you’ll only pay interest for the first several years. This introductory period is usually either 5 or 10 years, and your monthly payments will be significantly smaller during this time. If you’re in the market to buy a home and you’re not planning to pay cash, chances are high that you’ve either already spoken with a lender or you’re planning to do so in the near future. While there may be limited wiggle room with your budget and credit history, your lender is a valuable resource when it comes to determining an effective loan strategy for the purchase of your new home.