Interest-Only Versus Fully-Amortizing Mortgage

May 21, 2009

The table below compares a $100,000 mortgage with and without an interest only option for 10 years. It is assumed that the borrower exercises the option every month during the 10 years.

The borrower who makes the larger fully amortizing payment gradually reduces the balance, and has repaid about $16,000 of it by the end of the 10th year. The borrower who pays interest only does not begin to reduce the balance until year 11.

Required Payments on a $100,000 30-Year Mortgage at 6.25%, With and Without a 10-Year Interest-Only Option

 

Fully Amortizing Payment

Interest Only Payment

Pmt

Interest

Prin.

Balance

Pmt

Interest

Prin.

Balance

Mon

First Year

1

615.72

520.83

94.89

99,905

520.83

520.83

0

100,000

2

615.72

520.34

95.38

99,810

520.83

520.83

0

100,000

3

615.72

519.84

95.88

99,714

520.83

520.83

0

100,000

4

615.72

519.34

96.38

99,617

520.83

520.83

0

100,000

5

615.72

518.84

96.88

99,521

520.83

520.83

0

100,000

6

615.72

518.34

97.38

99,423

520.83

520.83

0

100,000

7

615.72

517.83

97.89

99,325

520.83

520.83

0

100,000

8

615.72

517.32

98.40

99,227

520.83

520.83

0

100,000

9

615.72

516.81

98.91

99,128

520.83

520.83

0

100,000

10

615.72

516.29

99.43

99,029

520.83

520.83

0

100,000

11

615.72

515.77

99.95

98,929

520.83

520.83

0

100,000

12

615.72

515.25

100.47

98,828

520.83

520.83

0

100,000

 

Eleventh Year

121

615.72

438.74

176.98

84,060

730.93

520.83

210.10

99,790

At the end of the interest-only period, the payment is increased to $730.93. It is larger than the payment on the loan that was fully-amortizing from the beginning because it must pay off the loan over 20 years rather than 30. 

Note that the example assumes that the interest rate is fixed over the entire life of these loans. Most interest-only loans, however, are adjustable rate, which means that the rate is very unlikely to be the same 10 years down the road. 

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