So you've heard about interest only mortgages. Maybe your neighbor bragged about his tiny mortgage payment, or your financial advisor mentioned it as an option. Let me tell you straight up – these aren't your grandma's mortgages. They work differently, feel differently, and if you're not careful, they can bite.
I remember sitting across from a client last year – let's call him Dave. Dave was thrilled about his new interest only loan. "My payment dropped by 40%!" he said. Fast forward three years, Dave was sweating bullets about the principal balloon payment coming due. That's why I'm writing this. Not to scare you, but to show exactly how these work.
What Actually Is an Interest Only Mortgage?
At its core, an interest only mortgage lets you pay just the interest charges for a set period (usually 5-10 years). Unlike a traditional mortgage where each payment chips away at your loan balance, you're only covering the cost of borrowing. The original loan amount? That sits untouched.
| Payment Type | Traditional Mortgage | Interest Only Mortgage |
|---|---|---|
| Monthly payment during initial period | Principal + interest | Interest only |
| Amount owed after 5 years ($500k loan @ 4%) | ~$458,000 | $500,000 (unchanged) |
| Payment shock risk | Low | High when interest-only period ends |
During the interest only term, your payments look something like this:
- Loan amount: $400,000
- Interest rate: 5%
- Monthly interest payment: $1,667 ($400k x 5% / 12)
- Principal reduction: $0
See that zero principal reduction? That's what keeps Dave up at night. When your interest only period ends, you'll need to start paying principal too. Your payment could easily double overnight.
Who Actually Uses These? (Spoiler: Not Everyone Should)
| Good Candidates | Risky Candidates |
|---|---|
| Property investors flipping houses quickly | First-time homebuyers stretching their budget |
| Bonus earners with irregular high income | Those without concrete repayment plans |
| Strategic planners with investment returns > loan rate | People banking on home price inflation |
I once worked with a surgeon who used an interest only loan perfectly. Why it worked:
- His $120k annual bonuses covered the future principal
- He invested the monthly savings into his practice
- He sold his previous home at profit for the balloon payment
Then there was Sarah. She took an interest only loan because the payment fit her waitress salary. No investment plan, no exit strategy. When property values dipped in 2020, she owed more than her condo was worth. Still makes me angry when lenders don't explain this properly.
The Real Costs Nobody Talks About
You'll hear about the low payments. What they don't mention:
- Higher interest rates: Expect 0.25% - 0.75% more than conventional loans
- Shorter terms: Most cap at 10 years interest-only before reverting
- Refinancing nightmares: If home values drop, you might get stuck
And those "low payments"? They're temporary. When your interest only period ends:
- The remaining term shortens (25 years left on a 30-year loan)
- Your payment now includes principal
- Result: Payment jumps 40-100% overnight
Payment Shock Example: $500k loan @ 4% for 30 years
- Years 1-7 (interest only): $1,667/month
- Years 8-30: $2,841/month (70% increase)
The Approval Minefield
Getting approved for interest only mortgages is tougher since the 2008 crash. You'll need:
- Exceptional credit: 700+ FICO is standard, 740+ preferred
- Solid repayment plan: Lenders want specifics (e.g., "I'll sell investment property X")
- Higher down payment: Often 20-30% minimum vs. 3-5% conventional
What frustrates me? Lenders claiming "easy approval" online. In reality, you'll need documents proving your repayment strategy. One client had to provide:
- Stock portfolio statements
- Rental property appraisals
- Notarized letter from his employer about bonuses
Top 5 Repayment Strategies That Actually Work
If you go this route, have a REAL plan for the principal:
- The Sale Plan: Intend to sell before the term ends (works best for flippers)
- The Investment Plan: Regularly invest the payment difference (must outperform loan rate)
- The Bonus Plan: Use predictable bonuses/commissions (documented history required)
- The Refinance Gamble: Hope rates stay low enough to refinance later (risky!)
- The Hybrid Approach: Make occasional principal payments when possible
Warning: Banking on home appreciation is NOT a strategy. I saw this backfire hard in 2008 when values dropped 30% in my market. People owed $400k on homes worth $350k with no way out.
Current Lender Requirements (The Real Deal)
| Lender Type | Minimum Down Payment | Repayment Plan Requirements | Interest Only Period |
|---|---|---|---|
| Big National Banks | 30%+ | Detailed written plan + proof | 5-7 years max |
| Portfolio Lenders | 20-25% | Verbal explanation acceptable | Up to 10 years |
| Private Money | 15-20% | Minimal - asset based | Flexible (1-10 years) |
Pro tip: Smaller portfolio lenders often offer better terms for interest only loans. Why? Because they don't sell loans to Fannie Mae. But they'll scrutinize your assets more closely.
Frequently Asked Questions (Real Talk Edition)
Q: Can I convert to a traditional loan later?
A: Maybe. Depends on your equity and credit then. If home values drop or your income decreases, you might be stuck. Refinancing isn't guaranteed.
Q: Are interest only mortgages cheaper long-term?
A: Rarely. You pay more interest over the life of the loan because you're not reducing principal initially. That $400k loan at 5%? You'll pay about $100k more in interest versus a 30-year fixed.
Q: What happens if I can't pay the balloon?
A: Worst case? Foreclosure. Better options: refinance (if possible), negotiate partial payment, or sell the property. Start planning 2-3 years before the term ends.
When to Seriously Avoid Interest Only Mortgages
Based on what I've seen blow up:
- If you're maxing your budget: Payment shock will break you
- If your job isn't stable: Commission-based? Reconsider
- If you're not disciplined with investments: That "extra cash" often gets spent
- If you plan to stay long-term: The math rarely works beyond 10 years
Honestly? I've seen more people hurt than helped by interest only loans. They tempt you with low payments but require military-level financial discipline. Unless you're a savvy investor with multiple exit strategies, think twice.
Better Alternatives Worth Considering
If interest only mortgages scare you (they should!), look at these:
| Option | How It Helps | Downsides |
|---|---|---|
| 7/1 ARM | Low fixed rate for 7 years, then adjusts | Rate uncertainty later |
| Extended Term Loans (40 years) | Lower payments than 30-year loans | More interest paid overall |
| Fixed-rate + rental unit | Use rental income to offset payments | Landlord responsibilities |
One client used a 40-year loan instead of interest only. Payment was only $150 more monthly, but she was paying down principal from day one. Slept much better at night.
Red Flags in Loan Offers
When shopping for interest only mortgages, run if you see:
- "No repayment plan needed" claims
- Prepayment penalties over 3 years
- Adjustable rates after the interest-only period
- Balloons requiring full repayment in 10 years
Last thought? Treat interest only loans like power tools. Useful for pros, dangerous for beginners. If you don't fully understand amortization schedules and have three exit strategies, stick to conventional financing. Your future self will thank you.
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