# Understanding Interest-Only Mortgages: How They Work, Advantages, and Risks

## What Is an Interest-Only Mortgage?

An interest-only mortgage requires borrowers to make only interest payments for a specific period. This structure allows for lower initial payments compared to standard [mortgages](https://www.investopedia.com/terms/m/mortgage.asp), but it also poses risks. Typically offered as adjustable-rate loans, these mortgages transition to include principal payments after the interest-only phase, significantly raising monthly obligations. They can be appealing for those seeking initial cash flow flexibility; however, they require careful planning to manage future higher payments.

### Key Takeaways

*   An interest-only mortgage allows borrowers to pay only interest for a set period, with principal repayments beginning later.  
    
*   These loans are often structured as adjustable-rate mortgages, where the interest rate may change after an introductory period.  
    
*   While interest-only mortgages offer lower initial payments, they do not help build equity and can lead to significantly higher payments once the principal comes due.  
    
*   Borrowers may face increased default risk if they are unable to manage larger payments when required.  
    
*   It's important for borrowers to anticipate future cash flow to ensure they can meet obligations when principal payments start.  
    

![Interest-Only Mortgage: A property loan that requires the borrower to only pay interest on the amount borrowed, for a set period.](https://www.investopedia.com/thmb/n4Ah5eqaOVWww5Z-3J36AmsWFks=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/interestonlymortgage.asp-1-FINAL-1-4df5439f8ea04fe9a2bdf2908be5900d.png)

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## How Interest-Only Mortgages Operate

Interest-only mortgages can be structured in various ways. Interest-only payments may be made for a specified time period, may be given as an option, or may last throughout the duration of the loan. Some lenders may offer interest-only payments to select borrowers.

Most interest-only mortgages require only the interest payments for a specified time period—typically five, seven, or 10 years. After that, the loan converts to a standard schedule—a [fully-amortized](https://www.investopedia.com/terms/f/fully_amortizing_payment.asp) basis, in lender lingo—and the borrower’s payments will increase to include both [interest](https://www.investopedia.com/terms/i/interest.asp) and a portion of the principal.

Usually, interest-only loans are structured as a particular type of [adjustable-rate mortgage (ARM)](https://www.investopedia.com/terms/a/arm.asp), known as an [interest-only ARM](https://www.investopedia.com/terms/i/interestonlyarm.asp). You pay just the interest, at a fixed rate, for a certain number of years, known as the introductory period. After the introductory period ends, the borrower starts repaying both principal and interest, and the interest rate will start to vary. For example, if you take out a "7/1 ARM", it means your introductory period of interest-only payments lasts seven years, and then your interest rate will adjust once a year.

> **Important**
>
> Fixed-rate interest-only mortgages are not very common; they usually exist on longer, 30-year mortgages.

## Options for Repaying an Interest-Only Mortgage 

Borrowers have several options when the interest-only mortgage term ends. Some borrowers refinance their loan after the interest-only term for new terms and potentially lower payments. Others may sell their mortgaged home to pay off the loan. Still, other borrowers may opt to make a one-time lump sum payment when the loan is due—having saved up by not paying the [principal](https://www.investopedia.com/terms/p/principal.asp) all those years.

## Important Factors to Consider With Interest-Only Mortgages 

Some interest-only mortgages may include special provisions that allow for just paying interest under certain circumstances. For example, a borrower may be able to pay only the interest portion on their loan if damage occurs to the home, and they are required to make a high maintenance payment. In some cases, the borrower may have to pay only interest for the entire term of the loan, which requires them to manage accordingly for a one-time lump sum payment.

## Pros and Cons of Interest-Only Mortgages 

Interest-only mortgages lower monthly payments by excluding the principal portion. Homebuyers have the advantage of increased cash flow and greater support for managing monthly expenses. [First-time buyers](https://www.investopedia.com/terms/f/firsttimehomebuyer.asp) can defer large payments with interest-only mortgages, expecting higher future income.

However, just paying interest also means that the homeowner is not building up any equity in the property—only the repayment of principal debt does that. Also, when payments start to include principal, they get significantly higher. This could be a problem if it coincides with a downturn in one's finances—loss of a job, an unexpected medical emergency, etc.

Borrowers should cautiously estimate their expected future cash flow to ensure that they can meet the bigger monthly obligations, and pay off the loan when required. While interest-only mortgage loans can be convenient for several reasons, they may also add to default risk.

## The Bottom Line

Interest-only mortgages offer an initial period with lower payments, as borrowers only pay interest and not the principal. This can help improve cash flow and manage monthly expenses, especially beneficial for first-time homebuyers or those anticipating higher future earnings. However, this type of mortgage requires caution because only paying interest means you are not building equity in the property. When the interest-only period ends, payments can increase significantly, potentially creating financial strain if unexpected events occur. Borrowers should carefully assess their financial situation and future income prospects before committing to an interest-only mortgage to avoid the risk of default.  
  

> **Article Sources**
>
> 1.  Federal Deposit Insurance Corporation. "[Interest-Only Mortgage Payments and Payment-Option ARMs](https://www.fdic.gov/consumers/consumer/interest-only/index.html)," Select, "What is an I-O mortgage payment?"
>     
> 2.  Consumer Financial Protection Bureau. "[Consumer Handbook on Adjustable Rate Mortgages](https://files.consumerfinance.gov/f/documents/cfpb_charm_booklet.pdf)," Page 20.
>     
> 3.  Consumer Financial Protection Bureau. "[What Is an 'Interest-only' Loan?](https://www.consumerfinance.gov/ask-cfpb/what-is-an-interest-only-loan-en-101/)"