Learn something new every day
More Info... by email
An interest only amortization schedule details the monthly payment for a loan with an interest only option. In such a loan, there is a specific period of time when the borrower is allowed to pay only the interest portion of the loan, resulting in lower monthly payments for a specific duration. With a fully amortized loan, all of the payments that are made to the lender include an allocation towards the principal, or the amount borrowed, and an allocation towards the interest portion of the loan.
Most interest only loans are structured into two different and distinct periods. There is an interest only period during which the borrower is only responsible for paying the interest of the loan. The length of the interest only period will vary depending on the specific terms and conditions of the loan. After this is completed, the loan will restructure and will require fully amortized payments for the remainder of the loan term.
The advantage of an interest only loan is that it offers lower monthly payments during the early term of the loan. Borrowers who choose this type of loan often do so when they plan on selling or refinancing the home within a short period of time after the purchase. When home prices are in a period of rapid appreciation, an interest only loan provides a borrower the ability to make low monthly payments until the home is resold at a profit or refinanced.
This is how an interest only amortization schedule works. This example assumes that a borrower wants to purchase a home for $100,000 U.S. Dollars (USD) at an interest rate of 5.5%. If the loan is a 30-year mortgage, with a 15 year interest only option, the monthly payments for the first 15 years of the loan would be $458.33 USD. After the interest only period has elapsed, the fully amortized monthly payment for the second half of the 30 year loan term would increase to $817.08 USD.
In contrast to the interest only amortization schedule, if the same borrower chose a conventional 30-year mortgage, the monthly payment over the life of the loan would be $567.69 USD. The first payment of the conventional loan would consist of $458.33 USD for the interest on the loan and $109.46 USD that is allocated towards the principal. However the second payment of the conventional loan, while still totaling $567.69 USD, would consist of $457.83 USD for the interest and $109.96 USD for the principal. The last payment of the loan, again while totaling $567.79 USD, would consist of an allocation of $2.59 USD towards the interest and $565.20 towards the principal.
The above example illustrates a possible disadvantage of an interest only amortization schedule. With an interest only loan, the lower monthly payments in the beginning actually increases the total amount that the borrower repays to the lender. Taking the above examples, someone who borrows $100,000 USD with a conventional amortization schedule would repay $204,404 USD over the life of the loan. The borrower who opts for the interest only amortization schedule would repay $229,575 USD over the life of the loan.
Another possible disadvantage of an interest only amortization schedule is that the borrower who chooses to make only the interest only payment would not build any equity, outside of the property’s appreciation. With no payments applied towards the principal during the interest only period, the principal balance does not start to decrease until the borrower makes payments above the interest only amount. Consumers interested in a loan with an interest only option should contact a mortgage lender for more information.
One of our editors will review your suggestion and make changes if warranted. Note that depending on the number of suggestions we receive, this can take anywhere from a few hours to a few days. Thank you for helping to improve wiseGEEK!