Background and context

Interest-only (IO) mortgages were common in the 2000s and reappeared in niche markets after tighter post‑crisis underwriting. The product is simple: during the IO window you pay only interest, so the loan balance doesn’t drop. That gives lower early payments and more cash flow, but it transfers repayment risk to a later date. (Consumer Financial Protection Bureau: https://www.consumerfinance.gov)

How an interest-only mortgage works — a quick example

  • Loan: $300,000, interest rate: 5% (hypothetical)
  • Monthly interest-only payment: $300,000 × 5% / 12 = $1,250
  • After the IO period ends you must repay principal—either by higher monthly payments on the same loan, by refinancing, or by selling the home.

Types and common terms

  • Fixed-rate IO: Interest rate stays the same during IO phase; principal payments start later.
  • IO adjustable-rate mortgage (IO‑ARM): Rate can change, so both interest and future principal payments can vary.
  • IO for investment properties: Often used by investors focused on cash flow rather than immediate equity buildup.

Who may benefit

  • Short-term owners or flippers who plan to sell before the IO period ends.
  • Real estate investors who want to maximize near-term cash flow.
  • Borrowers with predictable, rising income (e.g., doctors in residency-to-practice transitions) who will be able to handle higher payments later.

Who should avoid IO loans

  • Buyers who plan to hold long-term and prefer steady amortization.
  • Borrowers without emergency savings or a concrete refinance or sale plan.
  • Anyone relying on house-price appreciation to solve higher post-IO payments.

Main risks to plan for

  1. Payment shock: Monthly payments can jump substantially when principal repayment begins. Model your worst‑case post‑IO payment before you sign.
  2. Refinance uncertainty: If rates are higher or credit is worse at IO maturity, refinancing may be costly or impossible. See “How closing costs change when you refinance a mortgage” for planning (closing-costs & refinancing).
  3. Market risk: If home values fall, selling to avoid higher payments could be difficult.
  4. Adjustable-rate exposure: An IO‑ARM can combine rising rate risk with payment shock.

Practical checklist before taking an IO mortgage

  • Run numbers: Calculate post‑IO payments assuming rates rise 1–2 percentage points and your loan amortizes over the remaining term.
  • Build reserves: Save 3–6 months of full post‑IO mortgage payments and housing costs.
  • Plan an exit: Confirm your refinance options, projected home-sale timeline, or income path to cover higher payments.
  • Confirm underwriting: Lenders may require higher credit scores, reserves, or larger down payments for IO loans—ask what triggers or documentation they need.

Strategies I use with clients

  • Only use IO when there’s a clear, documented short-term plan (sale, refinance at a lower rate, or guaranteed income increase).
  • Treat the interest-only phase as a budgeting window to accelerate savings for the inevitable payment increase.
  • If you’re an investor, model rental cash flow, vacancy, and maintenance stress tests rather than assuming constant rents.

Related reading

Tax and legal notes

Mortgage interest may be deductible subject to current tax law limits—confirm with the IRS or a tax professional (see IRS guidance). This entry is educational and not tax or legal advice.

Authoritative sources

  • Consumer Financial Protection Bureau — mortgage basics and loan features (https://www.consumerfinance.gov)
  • Federal Housing Finance Agency and lender guides on underwriting standards

Professional disclaimer

This article is for educational purposes and does not replace personalized financial, tax, or legal advice. In my practice as a mortgage advisor, I’ve seen IO loans help with short-term cash flow but cause serious strain when borrowers lack a clear exit plan. Consult a qualified lender, financial planner, and tax professional to evaluate your specific situation.