When Interest-Only Mortgages Make Sense

To figure out how your payments would work with an interest-only loan, check out the online Interest-Only calculator from BankingMyWay.com. To start, enter your expected mortgage amount, the term of the loan, how long the interest-only portion of the loan lasts and the interest rate you expect to pay.

Let's say your lender is offering you a rate of 6.7% on a $200,000 30-year FRM with an interest-only option for the first 10 years. (Rates on a regular 30-year FRM are currently 6.54%, according to BankingMyWay.com , and rates on an interest-only FRM tend to be a little higher.) Your monthly payments would start at $1,117, then jump by nearly $400 to $1,515 after 10 years, when you start making principal payments in addition to your interest payments.

It is this sudden increase in payments that places unwitting homeowners in financial jeopardy. But if you plan ahead for this increase -- and take advantage of the loan's flexibility by making significant prepayments when you can -- the start of your amortization period won't cause as many problems.

If you make an average prepayment of $200 a month over those first 10 years, you'll gain a $24,000 head start for when you start paying down your principal. Better yet, as of your first prepayment, you'll have lowered the amount of your next interest payment to $1,116. That's a reduction of just a dollar, but it highlights an important point: Most interest-only mortgages calculate how much interest you owe each month. As a result, prepayments not only lower your principal but they also lower your future minimum monthly payments.

As with all mortgage applications, make sure you understand the details of your loan fully before making a final decision, and discuss any questions with your lender before closing.