How to Work Out Interest Only Mortgage Payments
Understanding how to work out interest only mortgage payments is crucial for anyone considering this type of mortgage. Unlike traditional mortgages, interest only mortgages allow borrowers to pay only the interest on the loan for a set period, typically between 5 to 10 years. After this period, the borrower must either refinance the loan, pay off the remaining balance, or convert to a traditional mortgage with principal and interest payments. This article will guide you through the process of calculating interest only mortgage payments, helping you make an informed decision about your financial future.
Calculating the Monthly Interest Payment
To calculate the monthly interest payment on an interest only mortgage, you need to know three key pieces of information: the loan amount, the interest rate, and the length of the interest-only period. Here’s a step-by-step guide:
1. Determine the loan amount: This is the total amount of money you borrowed for your mortgage.
2. Find the interest rate: This is the annual interest rate expressed as a percentage. For example, if your interest rate is 4%, write it as 0.04.
3. Decide on the interest-only period: This is the length of time you will be paying only the interest on the loan. It is typically 5 to 10 years.
Formula for Monthly Interest Payment
Once you have gathered the necessary information, you can use the following formula to calculate the monthly interest payment:
Monthly Interest Payment = Loan Amount x Interest Rate x (1 – (1 + Interest Rate)^(-Number of Payments))
In this formula, the “Number of Payments” is the total number of months in the interest-only period. For example, if your interest-only period is 5 years and you make monthly payments, you would multiply 5 by 12 to get 60 payments.
Example Calculation
Let’s say you have a $200,000 loan with an interest rate of 4% and an interest-only period of 5 years. Here’s how you would calculate the monthly interest payment:
Monthly Interest Payment = $200,000 x 0.04 x (1 – (1 + 0.04)^(-60))
Monthly Interest Payment = $200,000 x 0.04 x (1 – 0.672)
Monthly Interest Payment = $200,000 x 0.04 x 0.328
Monthly Interest Payment = $2,000 x 0.328
Monthly Interest Payment = $656
In this example, your monthly interest payment would be $656.
Considerations for Interest Only Mortgages
While interest only mortgages may seem appealing due to lower monthly payments, it’s important to consider the following:
1. Paying only interest: Remember that during the interest-only period, you are not reducing the principal balance of the loan. This means that when the interest-only period ends, you will still owe the full loan amount, plus any interest that has accumulated.
2. Refinancing or paying off the loan: After the interest-only period, you will need to either refinance the loan, pay off the remaining balance, or convert to a traditional mortgage with principal and interest payments.
3. Higher payments in the future: When the interest-only period ends, your monthly mortgage payments may increase significantly, depending on the remaining balance and the new interest rate.
Conclusion
Calculating interest only mortgage payments is an essential step in understanding the financial implications of this type of mortgage. By following the steps outlined in this article, you can make an informed decision about whether an interest only mortgage is the right choice for your financial situation. Always remember to consider the long-term implications of paying only interest and plan accordingly to ensure you can manage the increased payments when the interest-only period ends.
