Savings with an Interest-Only Loan

An interest-only loan requires a smaller monthly payment each month than does a fully-amortized loan of the same amount. But how much do you really save with an interest-only loan?

The answer is that the amount you save in absolute terms depends entirely on the total amount of the mortgage. As most people are aware, for the first several years of a mortgage, the vast majority of your monthly payment is interest, with only a small portion going toward paying-down the principal of the loan.

In fact, the typical loan payment at the beginning of a mortgage is 83 percent toward interest with only approximately 17 percent being applied toward the reduction of the principal of the loan. Therefore, using a fully-amortized mortgage with a monthly payment of $1,000 as an example, approximately 17 percent of that $1,000, or approximately $170, goes toward paying off the principal at the beginning of a loan. This means that an interest-only loan will only reduce your initial monthly payment on a $1,000 per month mortgage by approximately $170. As time progresses the savings becomes greater each month.

Still, even at the end of five or ten years, the average length of an interest-only loan, the amount saved each month by not paying the principal portion of the monthly mortgage payment may not be as much as many people imagined when they took out their loan.

Still, a 17 percent saving in payments each month may be a sufficient savings in some cases. This is especially true on a large mortgage, say in the $1,000,000 range. Many wealthy investors who are purchasing large pieces of property can recognize a substantial savings each month by utilizing an interest-only loan. If the amount saved is properly invested the savings may outweigh the benefits of a fully amortized loan.