What is an interest-only mortgage? How to qualify for one

An interest-only mortgage lets borrowers pay just the interest portion of the loan's payment for a while. The ineterst-only payments usually last five to 10 years.

Since they include only interest, monthly payments for an interest only, or IO, loan start out lower than traditional mortgage payments. Then, payments increase when the interest-only phase ends.

Interest only mortgages appeal to people who want to keep their payments low for a short period while they wait to refinance or re-sell. 

What is an interest-only mortgage?

An interest-only mortgage increases cash flow by lowering financing costs in the short term. The loan does this by requiring only interest payments and no principal payments during the early years of the loan.

This type of mortgage often attracts investors who want to pay less in financing costs while renovating a home for re-sale or to lease later.

Most people who get interest only loans for real estate plan to refinance the loan or pay it off before its monthly paymentsincrease to include principal.

Borrowers looking for a long-term home loan should stick with standard mortgage loans like FHA and conventional loans.

...in as little as 3 minutes – no credit impact

How this differs from traditional mortgages

Conventional loans and other traditional home loans require both principal and interest payments starting with the first payment. With a 30-year fixed-rate loan, for instance, the principal balance decreases some each time the homeownermakes a payment. 

The principal decreases by small amounts in the early years of the loan. Gradually, the amortization schedule picks up speed as each payment directs a little more money toward principal and a little less toward interest. By the final years of the loan term, almost all of each payment goes toward principal.

For an interest-only, or IO, loan, the principal doesn't change at all during the initial interest only period. The monthly payments cover only the interest due on the loan balance. 

How do interest-only mortgage loans work?

An interest only mortgage works by deferring principal payments and requiring only interest payments to keep the loancurrent.

Let's take a closer look:

How much can an interest only loan save? A scenario

Let's consider a $400,000 loan at an interest rate of 7 percent. An interest-only mortgage would require $2,333 monthly during the interest.only period. A typical 30-year loan would charge $2,661 (not including property taxes, homeownersinsurance, and any other added charges).

That's a difference of $328 per month or $3,936 a year. That's probably not a game changer for a typical home buyer, especially considering the threat of higher payments later. But for an investor, that's $3,936 more to put into renovating a home for resale.

Refinancing or paying off the loan as soon as possible optimizes savings from an IO mortgage. For example, if the hypothetical borrower above waited until the interest only period ended, the payments would increase to $3,100 a month.

Typical loan term and structure

Interest-only mortgages usually feature a 30-year total term with the interest-only period lasting five to 10 years. Most feature adjustable-rates, though some lenders offer fixed-rate interest only products. 

Some IO loans require a balloon payment when the interest-only period expires instead of converting to principal + interest payments. A balloon payment means the entire balance would come due at one time. It's even more important to refinance or pay off these types of loans. 

What are interest only loans used for?

Real estate investors use interest-only loans to maximize cash flow for property improvements, but it's possible to use an interest-only mortgage to buy a primary residence.

Paying only interest on a mortgage can help some borrowers afford more expensive homes.

This strategy could work for people who anticipate income growth over the next few years. Someone who's in medical school and expects to be a high-earning specialist in a few years, for example, could take advantage of lower IO paymentsnow knowing they'd earn enough to make the higher payments later.

Similarly, homebuyers who know they'll moving and selling the home in a few years might consider an interest-only loan, especially in an area where housing prices increase quickly.

Borrowers should always have an exit strategy before agreeing to an IO loan. Worse case scenario is a buyer who gets surprised later when the interest only loan starts charging higher payments. Most borrowers prefer standard, fixed-interest rate mortgages.

...in as little as 3 minutes – no credit impact

Pros and cons of interest-only mortgages

IO mortgages work best when borrowers can benefit from lower payments now without getting stuck with higher payments later. Knowing the pros and cons of these loans can help borrowers achieve this balance.

Pros of interest-only mortgages

• Lower initial payments: This is the appeal of IO loans. They can create thousands a year in cash flow.
• Tax deduction benefits: Mortgage interest on a primary residence, up to $750,000, is tax deductible for taxpayers who itemize deductions.
• Optional principal payments: Most lenders allow voluntary principal payments during the interest-only period, giving you control over debt reduction timing.
• Access to higher-priced properties: For professionals expecting higher future income, like medical residents or law associates, these loans provide immediate access to better homes while managing current budget constraints.

Cons of interest-only mortgages

• No equity building: The loan's principal balance doesn't move during the interest-only period. You're essentially renting money without building ownership.
• Payment shock potential: Monthly payments can jump 25 to 30% or more when principal repayment begins. A $2,500 interest-only payment could increase to over $3,000.
• Higher total costs: Paying interest on the full principal amount for additional years increases lifetime loan costs compared to traditional mortgage types.
• Market vulnerability: Declining home values could leave you owing more than the property is worth, limiting options to refinance or sell.
• Stricter lending standards: Lenders require excellent credit scores, substantial down payments, and lower debt-to-income ratios which are usually more restrictive than conventional loan requirements.
• Limited availability: Interest-only mortgages are non-QM loans, meaning fewer lenders offer them compared to standard mortgage products.

How to qualify for an interest-only mortgage

Interest-only mortgages are riskier for lenders, so they follow stricter approval rules. Only well qualified borrowers can get approved:

Credit score requirements

Minimum credit score: FICO 700+ is typically required, though some lenders may go as low as 680. 

Debt-to-income ratio limits

Maximum DTI: 43 percent or lower is the standard debt-to-income threshold for interest-only mortgages. This ratio proves you can manage current obligations plus future payment increases. Understanding what constitutes a good debt-to-income ratio before applying helps you prepare your financial profile.

Down payment and reserves

Down payment: Expect to put down 20 percent or more of the purchase price. This is significantly higher than minimum conventional and FHA requirements which range from 3 percent to 5 percent down. 

Cash reserves: Lenders require substantial reserves beyond your down payment, similar to jumbo loan qualification processes. Many require borrowers to have two to six months of mortgage payments in savings.

Income verification standards

Lenders scrutinize both current income stability and future earning potential. These loans work best for:

• Medical residents transitioning to attending physician salaries
• Law associates expecting partnership track income
• Business owners anticipating revenue growth
• Trust fund beneficiaries with documented future distributions

Applicants who exceed all of these requirements tend to get lower interest rates on an IO loan.

Is an interest-only mortgage good for me?

Interest-only mortgages work best for borrowers with predictable financial trajectories and clear exit strategies. Your current income, future earning potential, and plans for the home determine whether these loans enhance your financial position or create unnecessary risk.

When interest-only loans work well

Consider a medical resident earning $60,000 annually but expecting $300,000 or more after completing residency. An interest-only mortgage gives this borrower access a higher-priced home now while keeping payments manageable during training. Once their income jumps, the payment increase becomes affordable.

Real estate investors often benefit from interest-only loans when flipping houses. Lower monthly payments preserve cashfor renovations and carrying costs. The goal: sell before the interest-only period ends, avoiding payment increases entirely.

When these loans create problems

Picture buying a home with a 5-year interest-only period, then losing your job as payments jump 30 percent. Without building equity during those first few years of the loan, refinancing becomes difficult. Worse, if home values decline, you might owe more than the property's worth. That's bad.

Another common scenario: a borrower assumes they'll sell before payments increase, but market conditions shift. Suddenly, selling isn't profitable, and they're stuck with payment shock they can't handle.

For most homebuyers, conventional loans provide better stability and predictable costs. The equity building starts immediately, and payment shock isn't a concern.

Interest only mortgage alternatives

If interest-only mortgages aren't for you, several alternatives can provide the benefits you're seeking without so much risk.

• Adjustable-rate mortgages (ARMs) offer lower initial payments like interest-only loans, but with a key difference: Every payment includes principal, building equity from day one. ARMs typically start with a reduced interest rate for three to 10 years before adjusting based on market movements. You get initial paymentrelief while steadily reducing your loan balance.
• FHA loans work well for borrowers who might struggle with conventional financing requirements. These government-backed loans accept smaller down payments and offer more flexible debt-to-income ratio standards, making homeownership more accessible.
• Conventional loans provide predictable payment structures that many borrowers prefer. Their straightforward qualification requirements avoid the complexity of interest-only products while offering stable monthly paymentsthroughout the loan term.
• Home equity lines of credit (HELOCs) serve existing homeowners who need payment flexibility. Rather than refinancing your entire mortgage to an interest-only structure, a HELOC lets you access home equity while keeping your primary mortgage unchanged. Better's digital HELOC can close in a matter of days, not weeks.

Before choosing any mortgage type, compare your options using online calculators to understand total costs and paymentscenarios.

Interest-only mortgage FAQs

Can I refinance to an interest-only mortgage?

Yes, you can refinance your current mortgage into an interest-only loan. This process requires a new appraisal and closing costs typically ranging from 2 to 6 percent of your loan amount. Weigh these upfront expenses against your potential monthly savings to determine if refinancing makes sense.

How much can I borrow with an interest-only mortgage?

Your borrowing capacity depends on income stability, debt-to-income ratio, and credit score. Most lenders require:

• Credit score: 680-700 minimum
• Down payment: 20 percent or more
• Cash reserves: Verifiable assets beyond your down payment

The qualification process often mirrors jumbo loan requirements with detailed financial review. Lenders approve higher amounts when you demonstrate clear capacity to manage payment increases after the interest-only period ends.

What happens if I can't make payments after the interest-only period?

Missing payments after your interest-only term expires puts you at risk of foreclosure. Before reaching that point, explore options like refinancing through types of mortgage loans, selling your property, or negotiating modified payment terms with your lender.

Borrowers who can't make higher payments may face negative equity if property values decline simultaneously, limiting refinancing and selling options. Plan ahead by building cash reserves and monitoring your local housing market.

Are interest-only mortgages a good option for first-time homebuyers?

No. Interest-only mortgages are generally not recommended for first-time homebuyers. They're better suited for those with specific financial strategies, such as real estate investors or professionals expecting significant income growth in the near future.

IO loans: A powerful tool, but not for everyone

Interest only mortgages can be a powerful tool for borrowers who monitor their cash flow and make plans they'll keep years into the future.

For most other mortgage shoppers, a 30-year fixed-rate loan or a 30-year adjustable-rate mortgage provides a more stable path to homeownership. 

Getting a preapproval from Better can show your home buying budget in as few as three minutes. 

...in as little as 3 minutes – no credit impact