Interest-only loans work differently from traditional amortizing loans, and it’s important to understand what that means for your repayment schedule and total cost over time.
How Interest-Only Loans Work
In an interest-only loan, your monthly payments cover only the interest charges for an initial period—typically between 3 and 10 years. During this phase, you don’t pay down any of the principal (the amount you originally borrowed).
Effect on Amortization
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No Amortization During Interest-Only Period:
Throughout the interest-only phase, your loan balance stays exactly the same. Since you’re not paying toward the principal, you don’t make any progress in reducing the amount owed. -
Amortization Starts Later:
After the interest-only period ends, you must start making payments that include both principal and interest. At this point, amortization begins: each payment gradually reduces your loan balance. -
Payments Increase After Interest-Only Period:
Since the entire principal still needs to be repaid (often in a shorter remaining period), your monthly payments will jump significantly after the interest-only phase. The loan then follows a regular amortization schedule, but over fewer years, making each payment larger.
Summary Table
| Period | What You Pay | Loan Balance | Amortization? |
|---|---|---|---|
| Interest-Only Phase | Interest Only | Stays the Same | No |
| Principal + Interest | Principal & Int. | Decreases Monthly | Yes (standard schedule) |
Why It Matters
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Short-term savings: Interest-only loans offer lower payments at first, which can help with cash flow.
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Long-term cost: You won’t build equity during the interest-only period, and your total interest paid over the life of the loan may be higher.
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Payment shock: Be prepared for a significant payment increase when the interest-only phase ends and full amortization begins.
Bottom Line
With an interest-only loan, you delay amortization at first, but once the interest-only period is over, you’ll need to start repaying the principal—often with larger payments. Always consider your long-term ability to afford these higher payments before choosing an interest-only loan.