Interest-Only Payments

Interest-only payments summary:

• Interest-only payments are payments on a loan that only cover the interest, not any portion of the principal. 

• If you make interest-only payments on your unsubsidized federal student loans while you’re in school, you could prevent interest capitalization.

• Making interest-only payments doesn't reduce the amount of money you owe. 

Interest-only payments definition and meaning

Interest-only payments are loan payments that apply only to the interest that accrues on the principal balance. The principal is the original amount you borrowed. 

Interest-only payments just apply to interest, not the principal. So they won't reduce what you owe. You could make interest-only payments for years and still owe the same amount on your loan. Interest-only loans are considered riskier than loans that require a full payment.

Key concept: Interest-only payments cover the interest that accrues on a loan but don’t reduce the balance owed.

More on interest-only payments

When you get a loan, you have to pay it back with interest. Typically, part of your monthly payment goes to interest, and part of it goes to the principal balance until it's all paid off. 

Some loans work differently. Your lender might let you pay only for interest for a short time, then pay principal and interest for the rest of the loan. 

Interest-only payments can keep interest from piling up, but they won't make a dent in the original balance. 

Related: Interest-only personal loan: Lower payments now, higher costs later

Interest-only payments: a comprehensive breakdown

Interest-only payments are offered with several types of loans. You might have this option if you plan to apply for:

• An adjustable-rate mortgage (ARM)

• A home equity line of credit (HELOC)

• Private or federal student loans

The type of loan determines how your interest-only payments work. 

If you take federal student loans, for example, you typically have the option of pausing loan payments while you’re in school full time. If your loans are subsidized, that means the government pays the interest for you. When you start repayment, your loan balance will be the same as it was before you paused payments.

For your unsubsidized loans, however, no one pays the interest for you while your loans are in deferment. If you don’t pay at least enough to cover the interest that accrues, it’ll be added to your loan balance. Then, interest will be calculated on the new, higher amount. Your loan balance will grow until you start making regular principal and interest payments.

Real-life examples of interest-only payments

Some HELOC lenders allow you to make interest-only payments during your draw period. When your draw period ends, typically five or 10 years down the road, you won’t have made a dent in the balance that you owe.

If you get an Achieve Loan, you’ll make a principal and interest payment during both the draw period and the repayment period.

When you enter repayment, your monthly payment amount is likely to spike sharply. Here’s an example.

Let's assume you get a $50,000 HELOC at 11.5%. You have a five-year draw period, followed by a 10-year repayment period. (For the sake of this example, we’ll assume you don’t borrow more during your draw period.) Here's what you'd pay:

• $479 in the draw period

• $703 in the repayment period

So should you make interest-only payments on a HELOC?

On the pro side, interest-only payments keep your loan from growing. And since they're smaller, they can be more affordable—short term—for your budget. 

The two big drawbacks are that:

• Interest-only payments don't touch the principal, so the amount of money you owe doesn't go down

• You’ll face much higher payments in the repayment period, which could strain your income

Making principal and interest payments during the draw period can help you chip away at what you owe. And you won't be surprised by a higher payment in the repayment period if you're paying the same thing over the entire term. 

Note: Examples are for informational purposes only. Interest rates and payments are for illustration only. Individual results vary.