What is an Interest-Only Mortgage?

An interest only mortgage (IO) is a type of loan that requires the borrower to pay only the interest of the loan in a specified number of years. The repayment of the principal starts after the fixed-term of the IO ends.

Mortgage Payment

The typical period of payment of an interest only mortgage is between 3 and 10 years. If for example you have a 30-year mortgage with a 7-year IO option, you do not pay the principal amount for seven years. This may sound a big financial relief because you only pay a small amount every month for 7 years. However, since you only pay for the interest, the loan balance remains unchanged and your monthly mortgage payment will increase significantly after 7 years.

Furthermore, the interest rates and monthly payments of a policy with an IO term both change over time because this kind of plan has an adjustable interest rate.

Risks of Interest Only Mortgage

Some risks involved in an IO mortgage are:

  • an increase in monthly payments
  • pre-payment penalties or additional fees for loans that are refinanced
  • refinancing a mortgage when the loan balance is higher than the estate's value can be very difficult