How To Calculate Interest Only Payments

Interest Only Payment Formula:

\[ Payment = balance \times \left(\frac{r}{12}\right) \]

Monthly Interest Payment:

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1. What Are Interest Only Payments?

Interest only payments are periodic payments on a loan where only the interest is paid, and the principal balance remains unchanged. These are common in certain types of mortgages and business loans.

2. How Does the Calculator Work?

The calculator uses the interest only payment formula:

\[ Payment = balance \times \left(\frac{r}{12}\right) \]

Where:

\( Payment \) — Monthly interest payment (in currency)
\( balance \) — Current loan principal balance
\( r \) — Annual interest rate (in decimal form)

Explanation: The formula converts the annual interest rate to a monthly rate by dividing by 12, then multiplies by the outstanding balance to calculate the interest due for that month.

3. When Are Interest Only Payments Used?

Details: Interest only payments are often used in: adjustable-rate mortgages (ARMs) during initial periods, commercial real estate loans, bridge loans, and certain investment property financing.

4. Using the Calculator

Tips: Enter the current loan balance and annual interest rate. The calculator will show the monthly interest-only payment amount. Remember this doesn't include any principal reduction.

5. Frequently Asked Questions (FAQ)

Q1: What happens after the interest-only period ends?
A: Payments typically increase to cover both principal and interest, which may result in significant payment increases.

Q2: Does the loan balance decrease with interest-only payments?
A: No, the principal balance remains the same during the interest-only period unless additional principal payments are made.

Q3: Are interest-only payments tax deductible?
A: For mortgages, interest may be deductible (consult a tax professional). The deductibility depends on loan purpose and tax laws.

Q4: What are the risks of interest-only loans?
A: Risks include payment shock when the interest-only period ends, no equity build-up during interest-only period, and potential for negative amortization if property values decline.

Q5: How does this differ from a regular amortizing loan?
A: In amortizing loans, each payment covers both principal and interest, gradually reducing the loan balance. Interest-only payments don't reduce the principal.