Table of Contents
An interest-only mortgage is a type of loan where you only pay the interest on the principal amount for a specified period, typically for a set number of years at the beginning of the loan term.
Unlike traditional mortgages, where you typically pay both principal (the original loan amount) and interest, with an interest-only mortgage, you’re only responsible for covering the interest costs for a set duration.
Interest-only mortgages are typically a jumbo loan product used to purchase high-end homes priced above the lending limits allowed by Fannie Mae and Freddie Mac. They are usually structured as adjustable-rate mortgages (ARMs), although some lenders offer them as fixed-rate loans as well.
Interest-Only Mortgage Rates
With the current lending environment, interest-only loans have become a rarity offered by a limited number of lenders. This scarcity reflects a shift in the lending market, where traditional loan structures are more predominant.
As a result, the rate chart below focuses on adjustable-rate mortgages (ARMs) – a more accessible and comparable alternative. The below rates serve as a trend until interest-only rates become more widely available.
|5/6 ARM Jumbo SOFR Purchase
|7/6 ARM Jumbo SOFR Purchase
|10/6 ARM Jumbo SOFR Purchase
Rates will vary significantly from lender to lender depending on the borrower is qualifications. The better your credit score, the larger your down payment, and the more financial reserves you have, the more likely lenders will offer you their best interest-only mortgage rates.
How Does an Interest-Only Mortgage Work?
When you use an interest-only mortgage loan to buy a home, you typically have 5-10 years where you only make interest payments. After that, you need to start making payments toward the loan principle. However, many borrowers refinance after the interest-only payment period ends.
These loans can be attractive initially because the monthly payments are lower during the interest-only period. However, they can become more expensive when you have to start paying off the principal, potentially resulting in higher overall costs than a traditional loan, where you pay both principal and interest from the start.
» MORE: See today’s refinance rates
Other Types of Interest-Only Home Loans
An interest-only mortgage doesn’t have to be used to buy a home. In fact, the most popular type of interest-only loan is the home equity line of credit. The HELOC allows pre-existing homeowners to borrow money using their homes as collateral.
HELOCs are typically set up as interest-only loans during the draw period when you can borrow against the line of credit. The draw period of a Home Equity Line of Credit (HELOC) refers to the initial phase during which you can access funds from the credit line. This period typically lasts around 5-10 years, and during it, you can borrow against the line of credit up to the predetermined limit.
You’re only required to pay the interest charges as long as the draw period lasts, though you can make payments against the loan principle if you choose.
Interest-only mortgages are also often used for construction loans, which cover the cost of a new home while it’s being built. In these situations, a buyer will often take out an interest-only loan to cover the cost of the land, the materials, the contractors, and the like. The loan is then structured to convert to a regular, fully amortizing loan once the home is finished and the new owner takes possession.
Who Is An Interest-Only Mortgage Good For?
Many high-net-worth borrowers, especially those not interested in long-term homeownership, frequently opt for an interest-only mortgage. Instead of tying up a bunch of money in an expensive home – they invest it. Due to the low monthly payments, an interest-only mortgage allows them to do that while reaping the benefits of any increases in home value when it comes time to sell.
And since the interest paid on up to the first $1 million in mortgage debt is tax-deductible, a well-to-do couple using an interest-only home loan can write off most of their housing costs. Not a bad deal.
Another type of borrower who may benefit from an interest-only mortgage loan is someone with substantial but irregular earnings – perhaps a small business owner or a salesperson who gets the bulk of their income from commissions or bonuses. For this type of borrower, an interest-only mortgage allows them to make minimal monthly payments when needed and then large payments against the loan principle when the money comes in. They’re still paying off the loan, they’re just doing it in irregular steps.
How to Qualify For An Interest-Only Mortgage
Borrowers must be well-qualified to be approved for these loans. Interest-only mortgage lenders often require credit scores of 720-740 or above. A sizeable down payment is also typical for interest-only mortgages – sometimes 30% or more, though some lenders may allow a 20% or less down payment – as with any mortgage, it helps to shop around.
Income requirements are similar to regular mortgages. Lenders want to see a debt-to-income ratio of 43% or lower. Unlike the housing bubble years, you can’t qualify for an interest-only mortgage simply based on your ability to cover the interest payments – you must be eligible based on your ability to cover the payments when the loan becomes fully amortized, both principal and interest.
In addition, interest-only mortgage lenders will usually require that you have demonstrated sufficient financial reserves to cover your fully amortized mortgage payments for a certain period. This may be as short as a couple of months, but some lenders may require reserves sufficient to cover payments for two or three years.
Thinking of an interest-only home loan? Use our interest-only mortgage calculator to calculate your payments.