Explain it like I’m 5
When you borrow money, you have to pay back two things: the money you borrowed (the principal), and a fee for borrowing it (the interest).
With a normal loan, every monthly payment covers a bit of both, so what you owe slowly shrinks to zero. With an interest-only loan, for the first few years you only pay the fee. Your payment is smaller — but you still owe every dollar you borrowed.
It’s like renting the money. When the interest-only years end, you have to start paying back the whole loan in fewer years, so your monthly payment jumps up. And because you kept owing the full amount for longer, you pay more interest in total.
Words you’ll see, in plain English
- Interest-only loan
- A loan where, for the first few years, you only pay the interest. Your payment is smaller, but you don’t pay back any of what you borrowed during that time.
- Principal
- The money you put in at the start, before any interest is added.
- Interest
- Money someone pays you for letting them use your money — or money you pay to borrow someone else’s.
- Amortization
- Paying off a loan bit by bit with equal monthly payments. Early payments are mostly interest; later ones are mostly paying down what you owe.
- Payment shock
- The jump in your monthly payment when an interest-only period ends (or an adjustable rate goes up).
- Balloon payment
- A big one-time payment due at the end of a loan, because the regular payments didn’t pay it all off.
More money words explained simply in our glossary.
How to use the interest-only calculator
- Enter the loan amount and rate.
- Enter the total length of the loan — often 30 years for a mortgage.
- Enter the interest-only years at the start, often 5, 7 or 10. If the whole loan is interest-only, the calculator shows the balloon payment due at the end.
- Compare the payments, the balance over time and the total interest with a normal loan.
The formulas
Interest-only payment = loan × yearly rate ÷ 12
Payment afterwards = loan × r ÷ (1 − (1 + r)−n)
where r = yearly rate ÷ 12 and n = months left after the interest-only period.
Example: $400,000 at 6% for 30 years, the first 10 interest-only.
- Years 1–10: $400,000 × 0.06 ÷ 12 = $2,000.00 a month. After 10 years you still owe $400,000.
- Years 11–30: $400,000 paid off over 20 years = $2,865.72 a month.
- A normal 30-year loan would cost $2,398.20 a month the whole time.
- Total interest: $527,774 vs. $463,353 — $64,421 more for the interest-only loan.
Interest-only payments on a $300,000 loan
| Rate | Interest-only payment | After 10 yrs (20 left) | Normal 30-yr payment |
|---|---|---|---|
| 5% | $1,250.00 | $1,979.87 | $1,610.46 |
| 6% | $1,500.00 | $2,149.29 | $1,798.65 |
| 7% | $1,750.00 | $2,325.90 | $1,995.91 |
| 8% | $2,000.00 | $2,509.32 | $2,201.29 |
Pros and cons
- Pro: lower payments at first, which can help if your income is uneven or about to rise.
- Pro: flexibility — you can usually pay extra when you want to.
- Con: payment shock when principal payments start.
- Con: no equity built from payments during the interest-only years. If home prices fall, you could owe more than the home is worth.
- Con: more interest overall and often adjustable rates that can rise.
Common mistakes
- Budgeting for the low payment only. Make sure you can afford the payment after the interest-only years.
- Counting on refinancing. Rates, home values and your income could all be different when the interest-only period ends.
- Forgetting taxes and insurance, which are on top of the payments shown here.
Learn more
- Interest-Only Mortgages Explained Simply — With an interest-only mortgage you pay just the interest for the first years, so your payment is lower — but your balance doesn’t shrink, and the payment jumps when the period ends. Here’s the full picture with real numbers.
Frequently asked questions
How do you calculate an interest-only payment?
Multiply the loan amount by the yearly interest rate, then divide by 12. A $400,000 loan at 6%: $400,000 × 0.06 ÷ 12 = $2,000 a month. That pays the interest only; the amount you owe doesn’t go down.
What happens when the interest-only period ends?
You start paying back the loan itself, squeezed into the years that are left, so the payment jumps. On a $400,000, 30-year loan at 6% with 10 interest-only years, the payment goes from $2,000.00 to $2,865.72 — about 43% more.
Do you pay more interest with an interest-only loan?
Yes, usually much more, because you owe the full amount for longer. In the example above you’d pay about $527,774 in interest, versus $463,353 with a normal 30-year loan at the same rate.
Who uses interest-only loans?
People who expect their income to rise, who have irregular income such as commissions or bonuses, investors who plan to sell or refinance before the interest-only period ends, and some borrowers buying expensive homes. They’re riskier for most homebuyers because you don’t build equity unless the home rises in value.
Can I pay extra on an interest-only loan?
Usually yes. Any extra you pay reduces the balance, which lowers the next month’s interest-only payment and the later payment. Check your loan for prepayment penalties first.
Are interest-only mortgages still available?
Yes, but they’re less common than before 2008. Most aren’t “qualified mortgages”, so they’re often offered by smaller lenders or as jumbo loans, usually with higher down payments and credit-score requirements. Many have adjustable rates after a fixed period.
These results are estimates for education only, based on the assumptions you enter. They are not financial, investment or tax advice. Real returns, rates and taxes vary. See our methodology anddisclaimer.