How an Interest Only Mortgage Rate Differs From Rates Charged on a Traditional Mortgage

If you are considering an interest only mortgage, you may wonder how the rates charged on these loans differ from those on more traditional mortgage loans. It is a good idea to know what you are getting in to before you make the decision to go with a mortgage payment plan where you are only paying toward the interest, and not toward the principal.

When choosing an interest only mortgage plan, will the interest rate remain constant?

Not usually. There are a number of factors that come in to play that help to determine what your interest rate will be.

Different lenders and brokers offer varying interest rates, so it's a good idea to shop around and compare before you make any final decisions. Also, the interest rate on your interest only mortgage will often depend on fluctuations of the current index rate. Rates will change only occasionally, typically once in one year's time.

How do monthly payments compare on an interest only mortgage versus a traditional mortgage?

Interest rates are frequently higher on a 30-year fixed mortgage when compared to an interest only mortgage. For instance, you may pay 5.75% on a fixed mortgage, where you would pay closer to 3.5% or 4% on an interest only mortgage. However, remember that once your term ends on the interest only mortgage, your payments will be much higher as you begin to pay toward the principal.

Here is an example of the payment you could expect with a mortgage payment going toward interest only versus a traditional mortgage payment:

With a 5 year interest only loan that incurs an interest rate of 3.88%, your monthly payment on a $500,000 mortgage would be approximately $1,615. With a 30-year fixed or traditional mortgage, that same $500,000 mortgage at 5.75% interest would result in a monthly payment of $2,918. As you can see, this is a substantial amount of money - about $1,300.

How do you calculate the payments on an interest only mortgage?

Many people are curious as to how to calculate the payments they will have with an interest only mortgage. This process is easy.

Take the amount of your remaining mortgage, then multiply that amount by the current interest rate. Once you have that figure, divide it by 12 or the number of payments you expect to make in one year. If the interest rate is 3.75%, you will multiply your remaining mortgage balance (for example $230,000) and multiply it by .0375, then divide by 12. In this example, your monthly mortgage payment would be approximately $718.00.

When performing this calculation, be sure that you have taken out any previous payments you have made on your mortgage, and check that you are using the right interest rate as they may fluctuate.