Interest-only mortgages, in plain words.
On an interest-only mortgage, the monthly payment covers only the interest for a set number of years at the start of the loan. After that the payment covers principal as well, so it goes up, and the balance has not gone down in the meantime. This page explains both stages, who commonly looks at these loans, and the trade-offs. It quotes no rates and no payment figures.
Sam Batayneh is a mortgage loan originator (NMLS 332474) and VP of Mortgage Lending at OriginPoint (NMLS 1598647). Sam has originated mortgages since 2004 and lends in all of California. OriginPoint’s published materials list interest-only options on some jumbo loans.
How does an interest-only period work?
For a set number of years at the start, you pay only the interest on the loan each month. The balance stays where it began unless you choose to pay extra.
Every mortgage payment has two parts. Interest is what the lender charges for the use of the money. Principal is the part that pays the loan itself down. On a regular loan each payment holds both, from the first month to the last. On an interest-only loan, the first stage leaves principal out.
That first stage is the interest-only period, and its length is written into the loan papers. For example, a loan could have 10 interest-only years, then 20 years of principal and interest; other lengths exist. During it the required payment is smaller than it would be on the same loan with principal included, because nothing is going toward the balance.
You are usually allowed to pay principal anyway. Many people who choose these loans plan to do exactly that, in lumps, when a bonus is paid or stock vests. Whether an extra payment changes the required payment afterward depends on the loan’s own terms, so ask before you count on it.
Nothing about the interest-only period changes what you owe. On its last day the balance is the amount you borrowed, less only what you chose to pay down. The home’s value may have moved in either direction in the meantime, and the loan does not move with it.
This is general education. It is not advice about which loan to choose: that depends on your own plans and your own file.
What happens when the interest-only period ends?
The loan amortizes over the years that remain: each payment now covers interest and principal, so the monthly payment goes up.
During the interest-only period
The required payment is interest alone. The balance does not go down unless you pay extra. On a fixed-rate loan that payment stays level; on an adjustable-rate loan it can change when the rate does.
When the period ends
The payment is worked out again so that the whole balance is repaid over the years that are left. In the example above, a loan with 10 interest-only years, the balance would be repaid over the 20 years that follow.
For the rest of the loan
Each payment holds interest and principal, and the balance falls month by month until the loan is paid off at the end of its term.
To amortize a loan is to repay it in regular payments that each cover the interest due and a share of the balance. On a regular loan that starts with the first payment and runs the whole term. On an interest-only loan it starts late, and has to finish on the same date.
Two things make the new payment larger. Principal is now part of it. And the full balance has to be repaid in fewer years than the loan’s whole term, so each year carries a bigger share. The payment after the change is therefore higher than the interest-only payment, and also higher than the payment would have been on a loan that paid principal from the first month.
The date of the change is known from the day you sign. It is written in the loan papers, and the Loan Estimate you receive after applying shows that the loan has an interest-only feature and how the payment can change. Read that part before anything else, and ask Sam to walk through both stages of the payment with you.
People often plan to sell the home or to refinance before the change. Plans do not always hold. A sale can take longer than expected, and a refinance depends on your income, your credit and the home’s value at that time. Anyone who chooses an interest-only loan should be ready for the payment that follows.
Can a jumbo loan or an ARM be interest-only?
Yes. Interest-only describes the payment, so it can be a feature of a jumbo loan, and it is often paired with an adjustable rate. OriginPoint’s published materials list interest-only options on some jumbo loans.
Interest-only on a jumbo loan
A jumbo loan is above the county’s conforming limit, so the lender sets its own rules. On a larger balance the gap between the two stages of the payment is larger in dollars, which is why the second stage deserves a close look.
Jumbo loans in CaliforniaInterest-only on an ARM
Many interest-only loans are adjustable-rate mortgages. Then two things can change: the rate, when the fixed period ends, and the payment, when principal starts. The two dates may or may not be the same.
How adjustable-rate mortgages workOn an interest-only ARM, read the loan papers for both calendars: the fixed period and the caps that govern the rate, and the interest-only period that governs principal. A reset of the rate and the start of principal can land together, and the payment then moves for two reasons at once.
A fixed-rate loan can be interest-only too. Then only one thing changes: principal joins the payment when the interest-only period ends.
This description comes from OriginPoint’s published materials. Ask Sam about current availability. Program names are OriginPoint’s. Which one fits depends on your own file, and naming a program here is not a promise that a loan will be approved. OriginPoint publishes its own conditions and disclosures for each program, and those apply in full: ask Sam for them.
Who commonly looks at an interest-only loan?
People whose income arrives unevenly, and people who expect to sell or refinance before the interest-only period ends. These are common reasons for asking, not recommendations.
Bonus and RSU earners
Base salary covers the monthly payment, and bonuses or vesting stock arrive a few times a year. Some people plan to pay principal down in lumps when those arrive.
Mortgages for tech professionalsBonus and commission income
When a large part of the year’s pay comes as one bonus or as commissions, a smaller required payment between those dates can match the way the money arrives.
Mortgages for executives and finance professionalsSeasonal contract pay
Many playing contracts pay during the season only. Some athletes look at interest-only loans so that the required payment is smaller in the part of the year without a paycheck.
Mortgages for pro athletesPay that arrives unevenly
Income from film, television, music and online work arrives by the project and in uneven amounts, with gaps in between.
Mortgages for entertainersRental property owners
Some investors would rather keep cash for repairs or the next purchase than pay a loan down. The balance stays where it is, so the plan rests on the property.
Mortgages for real estate investorsPeople who expect to sell or refinance
Someone who expects to move, sell or refinance within the interest-only period may never reach the second stage. That is a plan, not a certainty.
General education only, not advice. An interest-only loan is not right for everyone, and uneven income is not by itself a reason to choose one.
What are the trade-offs of an interest-only loan?
No principal is paid down during the interest-only period, the balance is larger later, and lenders often qualify you on the full payment. Six things to weigh.
- No principal is paid down. During the interest-only period the balance stays where it started, unless you pay extra.
- A larger balance later. When principal starts, you owe more than you would on a loan that had been paying down all along, and there are fewer years left to repay it.
- A higher payment later. The payment after the period is higher than the interest-only payment. Ask to see both before you choose.
- More interest over time. Interest is charged on the balance. A balance that stays high for longer generally means more interest paid over the life of the loan.
- Equity comes from the market or from you. With no principal going in, equity grows only if the home’s value rises or you pay extra. If values fall, selling or refinancing can be harder.
- Qualifying is often on the full payment. Lenders commonly test income against the payment of principal and interest, so the smaller first payment does not by itself mean a larger loan.
What do lenders usually look at on an interest-only loan?
Reserves, assets, credit and the down payment, often read more closely than on a loan that pays principal from the start. Each lender sets its own rules, so this is a general list, not OriginPoint’s requirements.
Reserves
What you will still have after the down payment and closing costs are paid. Lenders often want to see enough set aside to carry the home through a lean stretch, and often more on a larger loan.
Assets
Recent statements for bank, brokerage and retirement accounts. They show where the down payment comes from, and what stands behind a plan to pay principal later.
Credit
Your credit history, and your monthly debts measured against your income. Lenders often look for stronger credit on an interest-only loan.
Down payment
The more of your own money is in the home, the more room there is if values move. Lenders often ask for a larger down payment on an interest-only loan.
Income is read as on any other loan: pay stubs and W-2s, tax returns for self-employment, and the history of any bonus, stock, commission or contract income. Bank Statement loans and loans that qualify on assets are other ways some borrowers document a file.
Plain answers about interest-only loans.
What is an interest-only mortgage?
What happens when the interest-only period ends?
Can a jumbo loan be interest-only?
Who uses interest-only loans?
Do you qualify on the interest-only payment?
General education only. Each lender sets its own rules, and they change. Nothing here is a promise that a loan will be approved or of any terms. This is not tax, legal or investment advice: for those questions, ask your own CPA, attorney or business manager.
Interest-only, or not?
Tell Sam how your income arrives and how long you expect to keep the home. Sam will lay out both stages of the payment, in plain words.