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How do I calculate my interest-only mortgage payments?

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Q: Can you help me? How would I figure out the payments on a 30-year fixed-rate loan with the first 10 years being interest only? They call it a "10 year interest only" loan. If the starting amount was $153,995, what would payments be for the first 10 years? What would they be after the 10 years is up? The bank rep said they would never change, but I am very confused as to how they cannot change when the first 10 years is different. I did not know how to do this on your calculator. Please help me.

A: If you have a 30-year fixed mortgage rate with interest-only payments for the first 10 years, you need to do the amortization in two parts in order to get your answer.

The first part is straightforward

Bring up our mortgage calculator and key in your loan amount ($153,995), the interest rate (for this example, I've used 3.75 percent), the term (30 years), starting month and year (I've used April 2013) and select “yes” in the "Show Full Table" dropdown.

The full table will display further down the page below, broken out by year. Next to the year is a little plus sign [+]; click the one next to 2013.

The line which displays April 2013 is your key line; it shows the interest component of your payment as $481.23--and this is your interest-only payment for the first 10 years of your loan.

Your payment will change

You are correct, though. Your payment WILL change, starting with the 121st month, when the loan switches from interest-only payments to fully-amortizing ones.

Importantly, it will do so over the remaining 20-year term, so you will see a substantial rise in monthly payments at that time--due both to the shortened remaining term of the loan AND that your loan amount is still the original $153,995 you began with.

Part two

The second part is easy, too: Go back to our mortgage calculator and change the term from "30 Year fixed" to "20 Year Fixed" and press calculate again.

The remaining 20 years of your mortgage, at an interest rate of 3.75 percent, with an amount of $153,995 will have a fully-amortizing monthly payment of $913.03--just under DOUBLE what you had been paying.

This sizable leap in monthly payment can really wreck a monthly budget, so before you jump into an interest-only product, you will need to be sure that you can handle the spike in payment later on. These products aren't called I/O ("I Owe") for nothing!

By comparison, a fully-amortizing payment over 30-years from day one will cost you $713.17 with no payment shock, ever.

About the author:

KTGA 25-year expert observer of the mortgage and consumer debt markets, Keith Gumbinger has been cited in thousands of articles covering a wide range of consumer finance and economic topics in outlets ranging from the Wall Street Journal to the Bottom Line newsletters. He has been a featured guest on national broadcasts for CNN, CNBC, ABC, CBS and NBC television networks and has been heard on NPR and other national and local radio programs. Keith is the primary researcher and writer for HSH.com's MarketTrends newsletter and has authored or co-authored a number of consumer guides on mortgages, home equity, refinancing and more.

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