Definition
Interest-only loan
An interest-only loan is a mortgage that requires the borrower to pay only interest for an initial period, often five to ten years, so the balance does not fall. When the interest-only period ends, the payment rises to repay the full principal over the remaining term, which can be a large increase.
During the interest-only period, the payment is simply the balance times the monthly rate. No principal is repaid, so equity grows only through a down payment, voluntary extra payments or appreciation.
Worked example. A borrower takes a $500,000 30-year loan at an illustrative 6% with a 10-year interest-only period. The payment for the first ten years is $500,000 × 0.5% = $2,500 a month. In year 11 the full $500,000 must be amortized over the remaining 20 years, so the payment jumps to about $3,582, roughly 43% more. A fully amortizing 30-year loan at the same rate would have cost about $2,998 from day one.
Interest-only structures appear in fixed-rate and adjustable-rate forms and are mostly offered through jumbo and non-QM programs, because loans with interest-only features generally fall outside the qualified mortgage definition. They can suit borrowers with irregular income who make lump-sum principal payments, or investors focused on cash flow. The core risk is payment shock combined with little equity if values fall. The interest-only mortgage calculator shows both payments.
Calculators that use this term
FAQ · 2 questions
Questions about Interest-only loan
What happens when the interest-only period ends?
The loan starts amortizing, so the payment rises to cover principal and interest on the full balance over the remaining years. The increase can be substantial.
Can I pay principal during the interest-only period?
Usually yes. Extra principal lowers the balance, which reduces the interest-only payment and the later amortizing payment. Check the note for any recast rules.
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