5 Best Secured Loans of January 2024

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. With most loans, your monthly payments go toward both your interest costs and your loan balance. Over time, you keep up with interest charges and gradually eliminate the debt owed. Home equity lines of credit, or HELOCs, are typically interest-only for the first 10 years. HELOCs are really second mortgages that work like credit cards – borrowers can draw money using equity as collateral.

With some lenders, paying the interest exclusively may be a provision that is only available for certain borrowers. As rising interest rates make home loans more expensive, an interest-only mortgage might look like a good way to lower your monthly payments. A hybrid mortgage can offer a lower initial monthly payment, similar to an interest-only loan.

• An interest-only loan allows borrowers to realize the benefit immediately.
• “payment shock.” Your payments may go up a lot–as much as double or triple–after the interest-only period or when the payments adjust.
• Here’s an interest-only loan example of what you would pay each month if you took out an interest-only home loan instead of a conventional mortgage.
• Here is an example to help you visualize the amount of money you pay toward loan interest rather than principal.

If you do take one of these loans, make sure to refinance prior to scheduled adjustment. Note that there would be absolutely no payment toward the principal in such a scenario, but you can still see the obvious advantage. While the lender only requires you to pay interest in the first term, you may decide to begin paying some of the principal if you can afford it. This shortens your loan term and allows you to pay off the loan balance faster. If you have an expensive month due to a home repair or medical bill, you can pay as low as the original interest-only payment to free up the cash you need. An interest-only loan example will help you understand how this type of mortgage works.

Secured vs. Unsecured Loans

Some people buy a second home and eventually turn it into their primary home. Making payments towards just the interest may be  convenient if you aren’t permanently living in the home yet. There were many types of subprime loans based on the interest-only model. Most of these were created after 2000 to feed the demand for subprime mortgages.

If you don’t have enough saved for the down payment required for a conventional mortgage, or if you can’t qualify for a conventional mortgage based on your credit score, an FHA loan may be a good option. Interest-only home loans require a smaller initial monthly payment that covers only the interest portion of the mortgage. Interest-only loans can be risky when the “interest-only” period is up and it’s time to start paying principal. Since new federal consumer-protection guidelines took effect in 2013, lenders know what sort of loans they can offer and to whom. If you’re drawn to interest-only loans because of the low monthly payment, explore government-backed loans like one from the Federal Housing Administration (FHA). These can give you more affordable payments without the future jump that comes with an interest-only mortgage.

Many homeowners got in trouble with interest-only loans during the housing crash in 2008. After their interest-only periods ended, they owed more on their homes than they were worth, and many couldn’t afford the higher principal-and-interest payments. Note that many interest-only mortgages are adjustable-rate mortgages, which have an APR that varies with the prime rate. So you may not have predictable fixed monthly payments with an interest-only home loan. Monthly payments for interest-only loans tend to be lower than payments for standard loans.

What Is an Interest-Only Loan?

If you ever need cash, you won’t qualify for a home equity loan until you pay down a significant portion of the principal. When your interest-only term is over, you’re responsible for paying down the principal in addition to this interest for the next 30 years of your loan term. Since the beginning of the loan term didn’t help to actually chip away at the loan balance, interest-only loans generally have longer terms than traditional loans. Interest-only loan terms are usually 30 to 40 years, so borrowers make a long commitment to paying off their home. These loans tend to have stricter underwriting requirements compared to conventional loans and are geared more towards borrowers with the financial background and assets to qualify for much larger loan amounts. An interest-only mortgage requires payments just of the interest — the “cost of money” — that a lender charges.

What is an interest-only mortgage and how does it work?

There is no expectation from the lender that you will direct a portion of your payment toward the principal. You obviously can do so and frankly should if it at all possible, but there is no cost of doing business for declining to do so. Her work has been published or syndicated on Forbes Advisor, SoFi, MSN and Nasdaq, free freelance independent contractor invoice template among other media outlets. Private lenders offer interest-only conventional and jumbo home loans, and these are usually structured like ARMs. There are several ways interest-only mortgages are structured, but the most common interest-only loans are structured similarly to adjustable-rate mortgages (ARMs).

Buying a House

Most mortgages require you to pay both interest and principal each month. In this scenario, your overall principal mortgage balance declines every month which means the interest charged is lower the following month. The biggest challenge may be finding a lender and then qualifying, because interest-only mortgages are not common.

When you apply for a conventional fixed-rate mortgage, you’ll lock in your APR and your monthly payments will remain the same over the entire term. An interest-only mortgage (IO mortgage) is a home loan that allows you to make only interest payments for an initial period. Following that period, you can either refinance, pay the remaining balance in a lump sum or begin making regular monthly payments. The benefit of an interest-only mortgage is that you can achieve low monthly payments during the first several years you own the home — but there are many drawbacks, and interest-only mortgages are considered risky. Here’s everything you need to know about how they work and how you can qualify.

Based on the same 30-year loan for $100,000 at an interest rate of 5%, the monthly payment would be $416.67 (lower than the amortized payment of $536.82). However, in this case, the entire amount goes toward the interest—the balance does not decline over time unless you make extra payments. In this example, the borrower pays $150,000 in interest (more than the total loan amount) and still owes the lender $100,000 when they get to the end of their loan term if they did not make any additional payments. For borrowers who want to buy an investment property or keep their monthly payments low for a set period, an interest-only loan could be a good option. However, there are trade-offs that come with those initial lower payments.

For example, some increase their income before the intro period is over. The remaining borrowers refinance to a new interest-only loan, but that doesn’t work if interest rates have risen. The first advantage is that the monthly payments on an interest-only mortgage are initially lower than those of a conventional loan. With an interest-only loan, you pay only the interest on the loan, not the amount of the loan itself (also known as your “principal”). Eventually, you’re required to pay off the full loan either as a lump sum or with higher monthly payments that include principal and interest. There are much less risky loans available than interest-only mortgages but that doesn’t mean taking out those loans requires less planning.