Is It Time to Reconsider Interest-Only Mortgages?
The U.S. housing market has been on a wild ride. After the Federal Reserve slashed rates to near-zero during the pandemic, mortgage rates climbed to 8% by late 2023, then began retreating as inflation cooled. As of this morning, the average 30-year fixed rate sits at just over 6%. It is still elevated by historical standards but down from its peak. For many prospective buyers staring at sky-high monthly payments, an old financing tool is whispering sweet nothings: the interest-only mortgage.
Once vilified after the 2008 crash, interest-only loans let borrowers pay just the interest for an initial period, typically 5-10 years, before principal repayment kicks in. The pitch is simple: lower payments now, flexibility later. But is 2025 the right moment to dust off this controversial product?
Why Interest-Only Loans Are Tempting Again
Interest-Only (“IO”) Loans may make sense in certain situations. For a sophisticated borrower, they are often a great option.
1. Cash Flow Is King in a High-Rate World - At 6.00%, a $500,000 loan carries a principal-and-interest payment of $2998/month. Switch to interest-only for the first 7 years, and that drops to $2,500/month—a savings of $498/month or $41,832 over the IO period.
For self-employed buyers, real estate investors, or high earners with lumpy income (think commissions or bonuses), that breathing room can be a lifeline.
2. Home Prices Haven’t Crashed - Inventory remains tight in most Sun Belt and coastal markets. The Case-Shiller Index shows national home prices up 47% since 2019, with only modest 2-4% pullbacks in overheated areas like Boise and Phoenix. However, if values hold or resume climbing once rates stabilize, paying less now to own the asset can make mathematical sense.
3. Refinance Escape Hatch - Unlike 2005, when borrowers were locked into exploding ARMs, today’s IO products often pair with fixed rates during the interest-only term. If rates fall to 5% by 2027 (a scenario Goldman Sachs places at 60% probability), the borrower can refinance into a traditional 30-year loan, potentially before principal payments begin.
The Risks Haven’t Vanished
However, as tempting as a lower payment through an IO loan is, there are risks with them that cannot be overlooked.
Payment Shock Is Real - When the IO period ends, payments jump. Using the example above:
Year 8 onward: $3,344/month (23-year amortization on $500k)
That’s a 34% increase overnight.
CoreLogic data shows 11% of IO borrowers in the 2004-2007 vintage defaulted when payments reset. While underwriting is stricter today (DTI caps at 43%, full documentation), life happens—job loss, medical bills, divorce.
The Borrower Is Not Building Equity (Unless Prices Rise) - Every dollar of interest is rent to the bank. If home prices stagnate or fall, the borrower emerges from the IO period with the same loan balance and potentially less net worth. Zillow’s latest forecast predicts 3.1% annual appreciation through 2029- decent, but not the 2021 rocket ship.
Investors Are Pickier and Pricier - IO loans aren’t back in a big way – yet. Only approximately 5% of 2024 originations were interest-only, per Black Knight. Borrowers will need:
20–30% down
720+ credit score
Higher income
Rates and pricing are generally higher - +0.25% to 0.50% on the rate versus a standard loan.
Regulatory Concerns – One item that makes IO loans harder and riskier is the regulatory environment. With Dodd-Frank, IO loans were classified as high-risk, non-QM lending. The panic that inspired Dodd-Frank (arguably one of the worst pieces of mortgage legislation in history) still exists. Borrowers, even those who think they are ready for an IO loan, may not fully understand the risks involved and may turn to litigation. Complete disclosure and acknowledgement by a borrower is crucial.
Who Should Consider It?
The Math: A Side-by-Side
Scenario: $800,000 purchase, 25% down ($200k), $600k loan
Rate: 6.00% fixed
IO Term: 7 years
While not for everyone, there are certain advantages to the IO. Lower payment in the beginning and freed up capital for the borrower. Also, even though the payment will go up at the beginning of year 8, is the borrower in a position where income growth would offset the payment increase? Also, the borrower may make additional principal at their discretion which would lower the payment shock in year 8. A strong possibility for borrowers whose income fluctuates.
The Conclusion
Interest-only loans aren’t the devil nor are they a silver bullet. They are a precision tool for sophisticated borrowers with strong exit strategies. In 2025, with rates likely peaking and inventory still constrained, they deserve to be considered. However, the higher interest rate may offset savings. A reconsideration of what is a non-QM loan would be helpful, but this is not likely in the cards in the near future.
For borrowers who are buying a forever home and can swing the full payment, they should stay with the traditional 30-year. But if your borrower is thinking of cash-flow optimization and betting on appreciation or a refinance, an IO loan should be considered.
A Call to Action
If your company would like information on training options for production staff or what The Commonwealth Group can do for your organization, contact Martin Luplow at [email protected] . The Commonwealth Group offers a variety of training, fulfillment, and consulting services for bank, credit unions, mortgage lenders, and mortgage brokers. After all, The Commonwealth Group is Innovative Services for the Mortgage Industry.
West Beibers, CMB, AMP, CRU
Chief Executive Officer
The Commonwealth Group Companies