"Interest Only" Loan Calculator

"Interest only" loans are becoming increasingly popular and so it is important to understand exactly how they work. An "interest only loan" allows a person to pay a smaller monthly payment at the beginning of the loan in order to save money (or in anticipation of a higher salary) so that a higher monthly payment is more affordable later in the loan.

A 30 year mortgage for $250,000 at 7% interest requires a monthly payment of $1,663.26. If this were an "interest only" loan, the monthly payment would be $1,458.33 which is about 12.3% lower. Is this savings worth it? Look at the chart below.

So, after 5 years of "interest only loan" payments, you have the "advantage" of "saving" $12,295.37 but you are left with 2 big drawbacks.

• You have absolutely zero equity in your house. To put this in plain English, how much of your house is actually yours? Absolutely nothing.
• While you have enjoyed the 5 years of "saving" $12,295.37 you have also lost five years that could have been used for earning equity in your home.

So now you have 2 choices.

1. Taking out a 30 year mortgage (which you could have done 5 years ago). You'll be making payments on your house for a total of 35 years the first 5 of which earned no equity and ended up costing $87,500.00.
2. If you don't want monthly payments for 35 years, you could take out a 7% 25 year mortgage and the monthly payments would be $1,766.95. That's over a hundred dollars more than the conventional 30 year mortgage.
   So, you have lost 5 years and $87,500.