Interest-Only Mortgage

This is not a type of mortgage, but an option you can add to any mortgage product (if available). With conventional loans, your monthly mortgage payment is allocated to both principal and interest. If you add this option -- let’s say, for the first five years -- you pay only interest during this five-year period. In the sixth year of your loan, you begin paying both interest and the principal. Adding this option can be problematic, however, as it will likely increase your monthly payment significantly once you begin paying both interest and principal.   

For example, say you have a 30-year, fixed-rate mortgage for $100,000. You add an interest-only option for the first five years. At the end of the five years, you start paying back interest and the principal. Because you have only paid interest over the last five years, you end up paying the entire $100,000 principal plus interest in 25 instead of 30 years. Basically, you end up paying a $100,000 mortgage over a 25-year term. 

Had you paid interest and principal in the beginning, the payment would be $537. With a 25-year term, the payments are $585.