Interest Only Mortgage vs 30 Year Fixed Calculator
Are you considering buying a new home? If so, use this calculator to create a comparison between two different kinds of home loans: an interest-only mortgage and a fully amortizing mortgage which repays principal. First enter the mortgage loan amount, its interest rate, and its term. Then provide optional information like annual real estate taxes, annual homeowners insurance, private mortgage insurance, and monthly association dues.
Click on “Calculate Payments” and you’ll receive a side-by-side comparison of monthly payments based on the two mortgage options.
Do you need to know the current market conditions in your local area? We publish current fixed, ARM & interest-only mortgage rates to help you make accurate calculations and connect with local lenders.
Today's Fixed & ARM Mortgage Rates
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Interest-Only Home Loans: What You Need to Know
When looking to buy a house, one of the most important decisions you can make is what type of mortgage you take out. Different types of loans may be best for different people, depending on the price of the house and your personal financial situation. There are so many available financing options, so how do you decide which is right for you? The first step is knowing the details of specific types of loans so that you can make an educated decision. One type of home loan that many buyers feel is a good fit for their financial situation is called an interest-only home loan.
What Is an Interest-Only Home Loan?
An interest-only home loan is a mortgage in which the borrower is only required to pay off the interest on the money, or the principal, that is being borrowed. When taking out this type of loan, the borrower is only required to make monthly payments consisting of the interest. Because of this, the principal remains unchanged. The option to pay interest only lasts a term of about five to 10 years, depending on the loan.
After this five- to 10-year term, borrowers have a few options as to how they want to proceed with the mortgage. The first option would be to renew the interest-only mortgage. Now if the mortgage is renewed, the borrower will go another five to 10 years without paying on the principal. The second option the borrower has would be to either pay the balance off by entering into a standard mortgage and make monthly payments or to liquidate investments.
For example, if you take out a 30-year loan of $100,000 at an interest rate of 6.25 percent, the monthly payment required by the terms of the interest-only loan would be $520.83. However, a borrower who took out the same mortgage without the interest-only option would have a monthly payment of $615.72. With the interest-only option on your mortgage, your monthly payment is reduced by $94.88. That difference would be the payment on the principal to reduce the balance.
An interest-only loan allows for the borrower to make lower monthly payments, since a percentage of the principal is not included per month. However, if borrowers choose to, they may pay more than the required monthly payment one month and begin to knock down the balance of the unpaid principal. Also, the interest rate remains fairly consistent with an interest-only loan since you are only paying off the interest.
Who Should Consider the Interest-Only Option?
The interest-only option is a perfect option for certain types of borrowers. Depending on the financial state of the borrower, this type of loan could be exactly what he or she needs. An interest-only home loan allows borrowers a lot of freedom when making payments and is forgiving of a borrower's unpredictable financial state.
Borrowers whose income fluctuates and are not financially stable would benefit from this type of loan. It would allow them to pay a higher payment to knock down the principal if they have extra income one month and to make the lower interest-only payment on tight months. Some borrowers benefit from this flexibility and the ability to pay extra when they are able to. One thing to think about if you are considering this type of loan and have a fluctuating income is whether you are disciplined enough to make extra payments when you are not required to. Consider whether you would spend the extra money or use it to pay off some of the principal.
Another borrower that may greatly benefit from this interest-only loan is someone who is looking to trade up to a larger home. Many people looking for a house that are in a tight financial state will initially buy a "starter house" and then move once their income has increased enough to afford the house they really wanted. An interest-only loan would allow borrowers to skip the initial starter house and move straight into the house they want now. With a low monthly payment and a pretty steady interest rate, this loan makes a more expensive house more affordable for someone with a low income.
One interesting feature that appeals to many buyers is that the monthly payments are responsive to extra payments made. So the month after you pay extra to reduce the balance of the principal, the required monthly payment will be a bit lower to account for the extra money you paid the month before. This is the only type of mortgage that has this responsive feature. This feature is also perfect for those with a fluctuating income, who may get a lump sum of money one month and are able to pay extra towards the principal. As a result, their next month's payment will be lower and more manageable.
What Are the Risks and Disadvantages of an Interest-Only Loan?
When looking over the terms and conditions of a loan, it is important to understand the disadvantages that could be associated with the loan. By understanding the disadvantages generally associated with an interest-only home loan, you will know what to watch out for when deciding which loan you want to invest in.
One major risk when getting into an interest-only home loan is getting deceived and not really knowing what type of loan you're getting into. Some interest-only home loans may seem better than they are, so it is important to be careful when researching and reviewing your mortgage. One thing that you can do as a borrower to prevent getting deceived and agreeing to a loan you do not want is by remembering that if two loans are identical, but one of them has an interest-only option, lenders will view the interest-only loan as riskier, resulting in a higher price.
Another disadvantage to taking out an interest-only loan is that if two loans are identical, but one of the has the interest-only option, you will end up paying more in the long run for that one. You could end up paying as much as 1 percent more on your mortgage for using the interest-only option. Consider whether it is worth it to you as the borrower to pay more over the term of the mortgage.
Borrowers also may get stuck with very high monthly payments once the interest-only term of the mortgage comes to an end. Since the borrower has not been paying on the principal for up to 10 years, there is a larger balance remaining at the end of this period. So the borrower must still pay the initial principal due, but over a shorter period of time than if a traditional mortgage had been taken out instead. This could result in missed payments and possible foreclosure on the house.
An interest-only home loan is a very unique type of mortgage and could be very helpful to certain types of borrowers. It allows borrowers to pay a lower monthly payment and gives them the flexibility to make additional payments to knock down the principal. This loan basically allows borrowers to buy now and pay later. The money that was actually borrowed for the loan does not need to be paid on for up to 10 years after the mortgage is taken out.
An interest-only loan gives borrowers a lot of freedom with their payments and time to increase income before paying on the principal. Just like any other type of mortgage, it is always important to research your loan and review your financial situation to be sure that you are taking out a loan that is right for you.
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