An interest-only (IO) loan requires you to pay only the interest on the outstanding balance during the IO period — no principal reduction occurs. Once the IO period ends, the loan re-amortizes over the remaining term, and your payment jumps to cover both interest and principal on the full original balance.
The calculator is pre-filled with Fixture F from the engine's verified test suite: a $400,000 loan at 5%, interest-only for 120 months (10 years), then fully amortizing for 240 months (20 years). The IO monthly payment is $1,666.67; the amortizing payment after month 120 is $2,639.82 — a jump of $973.15/month on the same balance you started with.
What happens during and after the interest-only period
During the IO window, your entire payment goes to interest. On the pre-filled example: $400,000 × (5% ÷ 12) = $1,666.67/month. Your balance after 120 months is still $400,000 — exactly what it was on day one. You have paid $200,000 in interest and own not one dollar more of the home than you did at the start.
After month 120, the loan re-amortizes. The $400,000 balance must now be repaid over the remaining 240 months at 5%. The payment formula gives $2,639.82/month — a $973 increase. This is the "payment shock" that catches IO borrowers off guard when they did not model it in advance.
Total interest paid over the full 30-year life of this loan is $433,557.51 (Fixture F, engine-verified). By comparison, a standard 30-year amortizing loan on $400,000 at 5% would cost $373,023 in total interest — the IO structure adds $60,534 in extra interest cost due to the 10 years of no principal reduction.
When interest-only loans are appropriate
IO loans have legitimate uses: property developers who need lower carrying costs during construction, investors managing short-term rental properties with a planned sale before the IO period ends, or high-income borrowers who prefer to deploy capital at higher returns elsewhere during the IO window and have high certainty of income continuity.
They are poorly suited for: primary residences where the owner plans to stay long-term (no equity building means no buffer against falling prices), borrowers who cannot confidently afford the higher post-IO payment, and situations where the exit strategy (sale, refinance) is uncertain.
Cross-link: IO is also a mode on the mortgage-payment calculator for modeling IO mortgage products specifically. This generic IO calculator works for any loan type.
IO vs standard amortization: the equity cost
A standard 30-year $400,000 / 5% mortgage builds equity from month one. By month 120, the balance is approximately $340,000 — meaning you have built $60,000 in equity through principal repayment. An IO loan on the same terms at month 120 has a balance of $400,000: zero equity built.
In a rising market, both structures benefit from appreciation. But the IO borrower has no principal-paydown buffer if the property value falls. A 15% price drop on a $500,000 property takes it to $425,000 — the standard amortizer at month 120 has $85,000 of equity buffer ($425k value - $340k balance); the IO borrower at month 120 has $25,000 ($425k - $400k).
This concentration of risk is why IO mortgages — common before 2008 — are now largely limited to professional investors and jumbo borrowers with substantial assets.
Frequently asked questions
What is an interest-only mortgage?
An interest-only mortgage requires you to pay only the interest portion of your loan during the IO period, with no principal repayment. Your balance stays the same throughout the IO window. At the end of the IO period — typically 5–10 years — the loan converts to a fully amortizing schedule for the remaining term, and your payment increases to cover both interest and principal.
How much does the payment increase after the interest-only period?
On the engine-verified example (Fixture F): $400,000 at 5% — IO payment is $1,666.67/month for 120 months, then the amortizing payment jumps to $2,639.82/month — a $973.15 increase (about 58% higher). The jump size depends on the loan balance, rate, and remaining amortization period. Use the calculator with your actual numbers to see your specific payment shock.
Do interest-only loans build equity?
No — not through principal repayment. An IO loan builds zero equity during the IO period through payments. You may gain equity if the property's market value rises (appreciation), but you do not build it by paying down the balance. Once the IO period ends and principal repayment begins, equity building starts on the remaining term.
Is an interest-only loan more expensive overall?
Yes. On the pre-filled example, total interest over 30 years is $433,557.51 vs $373,023 for a standard 30-year amortizing loan on the same $400,000 / 5% — an extra $60,534 in interest. The IO structure costs more because principal reduction is deferred, so you pay interest on the full balance for longer.