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- For the first few years of an interest-only mortgage term, you'll just pay interest each month.
- You might not qualify for an interest-only mortgage; you need a high credit score among other things.
- You won't build equity in your home until you start making payments toward the mortgage principal.
Mortgage rates should go down in 2024, but house prices will probably remain high — in fact, prices could even increase a bit as people who have been waiting for rates to drop enter the housing market and competition rises.
With decreasing mortgage rates and increasing home costs, an unusual type of mortgage might start to sound appealing: the interest-only mortgage.
What is an interest-only mortgage?
A mortgage is a loan for buying a home. When you get a regular mortgage, your monthly payments cover two main expenses:
- Mortgage principal: This is the amount you borrow from the lender. If you get a mortgage for $250,000, the principal is $250,000. You'll spread the principal out into monthly payments over the entire life of your mortgage.
- Mortgage interest: This is the fee the lender charges for borrowing money to buy your home. It's expressed as a percentage, such as 6.88% or 7.15%. Your interest payment is wrapped into your mortgage payment, along with the principal.
(You can also roll other home-related costs over into your monthly mortgage payments, such as property taxes and homeowners insurance. But the principal and interest are the two expenses associated with actually borrowing money.)
Interest-only mortgage payments work differently from traditional mortgages, though. Each month, you only make payments toward the interest, not the principal.
The interest-only period comes with a short term, usually 10 years or less. Interest-only mortgages are typically adjustable-rate mortgages, or ARMs, meaning the rate stays the same for while, then changes periodically.
For example, you may have a 10/20 interest-only ARM. This means you'll repay your mortgage over 30 years — the first 10 years will be interest-only payments, and the remaining 20 will be payments toward both the interest and principal. Terms vary by lender, but chances are your adjustable rate will change once per year.
Some lenders provide the option to sign up for a type of balloon mortgage. You'll make interest-only payments for the first few years, then pay the entire principal in one lump sum. This method isn't as common as switching to interest-and-principal payments, though.
Who can qualify for an interest-only mortgage?
Each lender has its own rules surrounding who qualifies for an interest-only mortgage. But in general, requirements are more stringent than for other types of mortgages. You'll probably need at least a 20% down payment and 700 credit score, and your debt-to-income ratio should be low.
Some lenders may require you to have a certain amount in the bank, or want to know about your income potential. They want to see whether you'll be able to afford higher payments later.
Should you get an interest-only mortgage?
Interest-only mortgage pros
- Low monthly payments. The biggest draw of an interest-only mortgage is that you'll pay less each month than if you were putting money toward the principal. Low payments can help you afford a home sooner.
- Good option if you expect to earn more later. This type of mortgage could be useful if you're confident you'll earn more money down the road. For example, you may know you're going to get your annual bonus at the end of the year, or you're due for a raise soon.
- Good option if you have strong finances. First, you need to have an impressive down payment, credit score, and debt-to-income ratio to qualify for an interest-only mortgage. Second, gaining equity in your home shouldn't be a huge part of your burgeoning financial portfolio, because it takes a long time to build equity with an interest-only mortgage. This type of mortgage could be a good fit for people who are buying an investment property rather than a primary residence.
Interest-only mortgage cons
- Adjustable mortgage rates. Most interest-only mortgages come with an adjustable interest rate. The good news is that adjustable rates are starting lower than fixed rates right now. But if rates rise in the future, your adjustable rate could increase, too.
- Building equity. 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.
- Potential to lose equity. Not only will you not build equity during the interest-only period, but you could actually lose equity. The housing market may decline, or your home might lose value for some other reason. For these reasons, getting an interest-only mortgage with plans to sell before the interest-only period ends is risky.
- Monthly payments increase. Yes, you'll make low payments for the first few years of your mortgage term. But keep in mind that you will have to make regular mortgage payments later, and if you don't plan accordingly, you may not be able to afford higher payments.
- Hard to find. Because interest-only mortgages are risky for lenders, not all companies offer them. You may need to spend time finding a mortgage lender that offers the terms you want.
You might like an interest-only mortgage if your finances are strong and you're not worried about building equity. Otherwise, you may want to look at another type of mortgage loan.
Interest-only mortgage FAQs
Can a mortgage be interest-only?
Yes, you can get an interest-only mortgage with certain lenders. You'll only pay the interest for an allotted amount of time, then you'll switch to making payments toward both the interest and mortgage principal.
Can you still get an interest-only mortgage?
Yes, you can still get an interest-only mortgage, but they're not very common. You may want to visit a mortgage broker whose job it is to find you the best lender for your situation, and tell them you're looking specifically for an interest-only mortgage.
What is the disadvantage of an interest-only mortgage?
The main disadvantage of an interest-only mortgage is that it's hard to build equity in your house. For the years you're only paying interest, you're not paying down your mortgage principal at all, so you're not gaining equity in your home. It's also possible your home could lose equity over that time if home prices drop.
What is a 30-year interest-only mortgage?
With a 30-year interest-only mortgage, your mortgage lasts for 30 years — but you'll only pay interest for part of that time, then make regular monthly payments for the remainder of the 30 years.
Why would anyone want an interest-only mortgage?
Someone might want an interest-only mortgage if they're buying an investment property, because they probably expect to hold onto the home for quite a while. This means it's not a big deal if it takes a long time to build equity, and their income could increase over the years, making it easier to afford the larger monthly payments when the interest-only period ends.
How long can I pay interest-only on my mortgage?
The amount of time you pay interest-only on your mortgage depends on your lender's terms. For example, a 10/20 interest-only mortgage lets you pay only interest for the first 10 years, then you'll add principal payments for the last 20 years.