Interest-Only Mortgage vs Fully Amortizing Mortgage

The table below compares the same 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. Copyright Jack Guttentag 2004

Jack Guttentag is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Visit the Mortgage Professor's web site for more answers to commonly asked questions.

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