How Interest-Only Mortgages Work: Pros and Cons

An interest-only mortgage offers a lower monthly payment at first and is best suited for people with ample assets, good credit and short-term ownership.
Hal M. Bundrick, CFP®
By Hal M. Bundrick, CFP® 
Updated
Edited by Alice Holbrook

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As rising interest rates make home loans more expensive, an interest-only mortgage might look like a good way to lower your monthly payments.

But these mortgages have stricter qualifications than typical principal-and-interest loans, and they're appropriate for only a narrow range of homeowning scenarios.

What is an interest-only mortgage?

An interest-only mortgage requires payments just of the interest — the cost of borrowing money — during the first years of the loan. After the interest-only period, you can refinance or pay off the loan or start making monthly payments of both principal and interest.

At that point, the payments will be higher than if you had paid principal and interest from the beginning. And, unless you opted to pay extra during the interest-only period, you won't have built equity in the home. Before you start repaying the principal, the only equity will be from your down payment and any gain in property value from rising home prices.

Interest-only loans are usually structured as adjustable-rate mortgages. After a specified number of years, the interest rate increases or decreases periodically according to an index. Adjustable-rate mortgages usually have lower starting interest rates than fixed-rate loans, but their rates can be higher during the adjustable period.

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