How interest-only mortgages work
By Jude Wallis
An interest-only payment is the annual interest charge divided by 12, and it repays nothing. On $400,000 at 6.5 percent the charge is $26,000 a year, which is $2,166.67 a month, and after any number of those payments the balance is still $400,000.
Interest-only payment
$2,166.67
$26,000.00 a year. The balance does not fall.
- Monthly payment
- $2,166.67
- Annual interest
- $26,000.00
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In short
- The payment is principal times rate, divided by 12: $400,000 at 6.5 percent is $2,166.67 a month.
- The annual cost is $26,000, and it does not fall from one year to the next because the balance does not fall.
- A smaller loan scales exactly: $250,000 at 5.5 percent costs $1,145.83 a month, or $13,750 a year.
- The full balance is still due at the end, so the plan for repaying it is part of the product.
- The payment is lower than an amortising one because it buys less, not because the debt is cheaper.
The simplest payment in mortgage lending
There is no amortisation schedule here and no solving for anything. Multiply $400,000 by 6.5 percent for an annual charge of $26,000, divide by 12 for $2,166.67, and that is the payment. It is the same in month one and month 120.
The reason it never changes is the reason the product exists: nothing is being repaid, so the balance the interest is charged on stays where it started. Every pound of the payment is the cost of having the money, and none of it is buying any of the asset.
The repayment plan is the product
Because the balance does not fall, an interest-only loan has to end in something other than the last payment. Usually that is a sale, a refinance onto an amortising loan, or a separate investment plan built to reach the balance by the end date.
Each of those carries its own risk. A sale depends on the property's value at a date you do not choose. A refinance depends on rates and on lending appetite when the term ends. An investment plan depends on returns arriving. That is why the end of the term deserves more attention than the payment does.
What the lower payment is buying
An amortising payment on the same $400,000 would be higher, and the whole of the difference is repayment rather than cost. So the saving is a cash flow choice, not a cheaper loan, and it converts into a larger balance carried for longer.
That can be the right trade. A landlord holding a property for income, a borrower with genuinely uneven earnings, or a bridging position ahead of a known sale all have reasons to pay for time rather than for progress. Interest-only against amortising puts the two payment structures on the same loan, and how amortisation works shows what the extra money buys.
Reading the total cost
Ten years of $26,000 a year is a large number with nothing repaid at the end of it, and that comparison is the one worth making before choosing the structure. Check the rate as well: interest-only rates are often higher, because the lender's exposure never falls. The interest-only mortgage calculator prices the payment, and the remaining loan balance calculator shows what an amortising loan would have cleared over the same period. This is educational material, not financial advice.
Worked examples
\$400,000 at 6.5 percent
A $400,000 interest-only mortgage charges 6.5 percent. What is the monthly payment?
- Annual interest is 400,000 times 0.065, which is $26,000.
- Divide by 12: $2,166.67 a month.
$2,166.67 a month, $26,000 a year, and the $400,000 balance is unchanged throughout.
\$250,000 at 5.5 percent
A smaller interest-only loan of $250,000 at 5.5 percent.
- Annual interest is 250,000 times 0.055, which is $13,750.
- Monthly that is $1,145.83.
$1,145.83 a month. The payment scales directly with both the balance and the rate, because there is nothing else in it.
Common questions
Does the balance ever fall?
Not from the scheduled payment. Only a voluntary overpayment or a lump sum reduces it.
What happens at the end of the term?
The full $400,000 falls due, so it has to be repaid, refinanced or amortised over the years remaining.
Why is the rate sometimes higher?
Because the lender's exposure does not amortise away, so the risk stays at its opening level for the whole term.
Is this financial advice?
No. It is educational material about how an interest-only payment is calculated.
Keep reading
This page is educational material, not financial advice. The figures come from the formula shown and assume the inputs you enter hold for the whole term. Your own rate, fees, taxes and timing will differ, so treat the output as arithmetic to check a decision against, not as a recommendation.