Mortgage Amount: how much you are borrowing to buy the house. This is often roughly equal to the purchase price of the house. The calculator only lets you specify amounts between $100,000 and $1,000,000.
Interest rate: the interest you will be paying during the interest-only term, NOT the interest you may pay after the interest-only period is over (the calculator does not estimate those costs). The calculator lets you specify between 1% and 18% (though you will almost certainly not get either such a low or such a high interest rate).
Term: the amount of time you will pay only interest. The calculator lets you select from 1 to 10 years. (Five years is the most common term)
Prepayments: amounts you will pay against the principal before the official end of the interest-only term. Prepayments give you the flexibility to pay down the principal when you can afford to and pay only interest when you cannot.
Prepayment amount: amount you will prepay. The calculator only allows you to select a single amount for the sake of simplicity. In reality, you have the option to prepay more than the agreed-upon prepayment amount.
Start Prepayment in Year: Will you make the prepayment as soon as you take out the mortgage (year 1) or wait a year or more?
Monthly payments: The amount you will pay per month during the interest-only term.
Total payments: The amount you will have to pay, at minimum, in order to buy the house using the figures you have supplied. This amount is the interest paid in the interest-only term, plus the actual principal. It does not factor in the interest you might pay on the principal if you cannot pay it in full (few people can) when the interest-only period ends.
Interest payments: The amount you will pay during the interest-only term, not counting any fees.
Summary: how much you will pay total, broken down according to principal (balloon payment) and interest.
Interest-Only Mortgage Explained
An interest-only mortgage is a loan to buy a house
, just like any other mortgage. You pay only the interest for a certain amount of time (term
). The term is usually up to 5 years, sometimes up to 10, and in rare cases up to 15 (note: the calculator only lets you input a term up to 10 years). The longer the interest-only term, the more you will have ended up paying for the mortgage total. If the interest-only term were to last forever, you would be paying only interest while never paying back the money you actually borrowed to buy the house in the first place. The interest-only term puts you no closer to owning the home outright, unlike the time you spend in a traditional mortgage.
During the interest-only term, you do not pay anything toward the principal
(original amount borrowed, usually the purchase price of the home plus any fees or closing costs not paid in advance, minus any prepayments or down payments). You build up no equity during the time you pay only interest, and so it is financially somewhat akin to renting.
However, if the value of the home goes up substantially, you will have the value of the increase in the property values over and above the original purchase price--something that can never happen while < href="renting.
By the same token, if the value of the home drops substantially, you will lose out just as much--something that can never happen while renting
When the designated interest-only term ends, monthly payments toward principal and remaining interest begin. You may also simply pay the remaining balance all at once in a single balloon payment
, though extremely few people can afford to do this. Note: in the calculator, the "balloon payment" refers to the amount you still owe after the interest-only term ends. The balloon payment
is what you would pay if you paid it all at once. However, repayment over time will incur additional interest and fees. Important note: the calculator does not reflect the interest and fees you will have to pay if or when you enter into a traditional mortgage at the end of the interest-only term.
Monthly payments toward principal after the interest-only period may have a fixed or adjustable interest rate. A fixed-rate mortgage will lock in the lower interest rate when you first took out the interest-only mortgage (interest rates are at relative historic lows and so will likely increase over time). An adjustable-rate mortgage (ARM) will mean you will pay more interest when interest rates rise, though many ARMs limit how high the interest rate can go. You may make prepayments
toward the principal even before the interest-only period expires.
Who Should Take Out an Interest-Only Mortgage?
- Borrowers who have the money to pay a traditional mortgage but who have a strong investment for the cash they save by not paying principal.
- Borrowers looking for the lowest possible monthly payment
- Borrowers whose main income is infrequent bonuses or commissions
- People who expect to greatly increase their income within a few years. Interest-only mortgages have historically been more common among lawyers and doctors just beginning a lucrative practice who want to pay down higher-interest educational debt before tackling a mortgage.