Could a 10/1 interest-only ARM save you money? Yes, it could — if you time it right.
During the first 10 years of the loan, a 10/1 interest-only ARM will require lower payments. Making lower house payments can free up money. You could invest the savings somewhere else.
After 10 years, the loan’s payments will increase. But by then, if you’re like many Americans, you would’ve sold or refinanced out of the loan anyway.Check your 10/1 interest-only eligibility.
What’s in this article?
What is a 10/1 interest-only ARM?
A 10/1 interest-only adjustable-rate mortgage (ARM) combines two out-of-the-box features into one loan:
- An adjustable rate: You’ll have a locked-in rate for the first 10 years, but after that the loan’s rate and payment will change each year
- Interest-only payments: You’ll be required to pay only interest for the first 10 years of the loan
During the first 10 years, these two features drive down monthly mortgage payments when compared to traditional financing.
For instance, a $500,000 loan at 7% 30-year fixed rate would require a payment of $3,327 per month. The same loan at 6% on a 10/1 interest-only would require only $2,500 per month, a savings of over $800 per month.
While the above rates are only for example purposes, you can see the effectiveness of an interest-only loan. You could qualify for a larger home and loan while keeping your monthly payments the same.
How does a 10/1 interest-only ARM work?
You could think of a 10/1 interest-only ARM as one loan with two parts.
- Part 1 is a 10-year portion that charges a fixed interest rate. Its payment will cover only the interest that accrues on the amount you borrowed. You won’t pay down principal by paying only the required payment.
- Part 2 is a 20-year, fully amortized, adjustable-rate mortgage (ARM). This part’s principal will gradually decrease with each monthly payment, and its rate will change yearly to match market conditions.
Part 1 will have fixed, level payments for 10 years. But after the first 10 years, a lot changes. Part 2 will require higher payments to accommodate repaying the loan’s principal.
For instance, your rate changes from 6% to 7% after year 10. At the same time, the loan converts into a fully amortized loan. Those two changes combined would take your payment on a $500,000 balance from $2,500 per month to $3,876. It’s easy to see why most people will try to refinance or sell before 10 years on a 10/1 interest-only loan.
And, the rate will keep changing, each year, for the life of the loan.
A lot of people think ARM rates always increase, but rates could also decrease depending on market conditions at each adjustment period.
Luckily, there are caps on how high the rate can increase. For example, the rate on a loan with a 2% periodic cap could not rise more than 2% at each adjustment period. And a 5% lifetime cap means the loan’s rate will never rise more than 5% above its original rate.
Why do some homebuyers choose an interest-only ARM?
Home buyers who want to close on a loan and then stop thinking about it should stick with a 30-year, fixed-rate mortgage. These loans have become a standard home financing product for a reason.
A 10/1 interest-only ARM is designed for strategic home buyers, buyers who like to poke around under the hood of their financial products — buyers who like to fine-tune their investments.
For example, home buyers who choose an interest-only ARM usually see the loan as a temporary way to save money. For up to a decade, they claim monthly savings. Then, they either refinance or sell the home within those first 10 years, meaning they never experience a change in the loan’s interest rate.
These buyers also know the 10/1 IO ARM’s principal will not decrease at first, and they’re OK with that. They understand the principal on a 30-year fixed doesn’t go down very much during the loan’s first couple years anyway. An interest-only loan isn’t all that different than a 30-year fixed in the first few years as far as paying down principal.
Who are 10/1 interest-only ARM mortgages good for?
So who are these buyers who like interest-only ARMs? These loans often work work well for borrowers who:
- Know they’ll move soon: Sticking around for just a year or two? A 10/1 interest-only loan could save you money. A 7/1 or 5/1 ARM may save even more.
- Have big plans for the savings: Investors who can earn returns that outpace the housing market can get ahead with a 10/1 IO ARM’s monthly savings.
- Will flip the house: Investors who buy, restore, and re-sell homes within a year or two often like interest-only payments. That way they can put more money into restoring the home and potentially earn a bigger profit from the sale.
- Invest in real estate: Interest-only payments can help real estate investors who plan to pay off the entire loan balance soon, after they sell another property.
- Want a more expensive home: Some homebuyers use the lower 10/1 interest-only payments to afford a more expensive home. These buyers expect the home to appreciate so they can sell or refinance more easily in a few years.
In all of these applications, the borrower plans to save money from the 10/1 interest-only ARM temporarily. Buyers don’t normally keep these loans beyond their first 10 years.See if a 10/1 interest-only ARM is right for you.
How to calculate your 10/1 interest-only payment
How much can you save each month with a 10/1 interest-only ARM?
You don’t need an interest-only mortgage calculator to find out. These loans simply divide the annual interest due into 12 monthly payments. Here’s the formula:
1% of your loan amount X interest rate / 12
Let’s say you’re buying a $600,000 home and putting 20%, or $120,000, down. This makes your loan amount $480,000. For this example, we’ll use an interest rate of 6.5%.
1% of your loan amount would be $4,800. Here’s the math:
$4,800 (1% of loan amount) x 6.5 (interest rate) =
$31,200 (yearly interest) / 12 = $2,600 per month.
That $2,600 payment would be $434 less than the payment on a 30-year fixed-rate loan. Over 10 years, you’d pay $52,080 less in mortgage payments.
|20% down payment||$80,000||$120,000||$160,000|
|30-year fixed payment**||$2,023||$3,034||$4,045|
|10/1 IO payment**||$1,733||$2,600||$3,466|
*Interest rates shown are for example purposes only and may not be currently available. Your rate will be different. Get a personalized mortgage quote here. **Does not include taxes, insurance, HOA, or other dues or fees.
Of course, at the end of those 10 years, you’d still owe the full $480,000 in loan principal. But some borrowers don’t mind because they’ve invested the $52,080 they saved into other real estate, securities, or business investments.
10/1 interest-only jumbo (non-conforming) loans
Most home loans conform to rules set by Fannie Mae and Freddie Mac, the two huge government-sponsored mortgage loan buyers. One of those rules sets a maximum loan amount. In 2022, for most areas of the nation, the maximum loan size is $647,200.
A loan that exceeds the conforming loan limit is called a non-conforming or jumbo loan.
An interest-only jumbo loan is particularly attractive to home buyers because it can shave a few hundred dollars off their monthly payments for a while.
Since the conforming loan limit tends to increase over time, it’s possible the home’s principal could fall within conforming loan limits in a few years — in time to refinance out of the 10/1 interest-only ARM.
What lenders offer 10/1 interest-only ARMs?
It’s unlikely you’ll find 10/1 interest-only ARMs and other IO loans at your local bank or credit union. Instead, check with online lenders who specialize in non-QM loans.
Non-QM means “non-qualified mortgage.” These loans don’t follow the specific rules set by Fannie and Freddie. Instead, a lender can decide for itself whether to approve your loan, and the loan is more likely to stay on the lender’s books.
Non-QM loans can offer flexibility to borrowers, but keep in mind these loans don’t have to follow Consumer Financial Protection Bureau rules. For example, they can charge a fee for paying the loan off early.
So be sure to read all the details of the loan — especially its rate caps and prepayment rules — before closing.
10/1 interest-only ARM rates
The non-QM lenders who specialize in 10/1 interest-only ARMs don’t usually advertise their rates. You’d need to get in touch with a lender to get a personalized quote for your unique loan scenario.
Generally, though, ARM rates start out lower than fixed loan rates, and a lower rate can amplify savings when you’re paying only interest.
Comparing rates from several different lenders can help you save, but be sure to compare fees and rate caps, too. These can have a bigger impact later in the life of the loan.
Are there 30-year fixed interest-only loans?
Some borrowers like the idea of paying only interest for a while, but they don’t like the uncertainty of an adjustable rate mortgage, or ARM.
A few non-QM lenders are offering a compromise: a 30-year fixed-rate loan that charges only interest for part of the loan term.
As with 10/1 IO ARMs, these 30-year fixed loans offer an interest-only payment period that will expire. Most of these fixed loans’ IO periods expire in either 10 or 15 years.
When the interest-only period ends, payments will increase as the lender adds principal to the mix. But the loan’s initial interest rate would remain locked into place.
10/1 interest-only mortgage pros and cons
- Lower initial payments
- Larger loan amounts possible
- Provides temporary savings
- Payment will increase in 10 years
- Rate will start changing in 10 years
- Can be hard to find lenders
10-year IO ARM alternatives
Standard adjustable-rate mortgages
- 3-year ARM
- 5-year ARM
- 7-year ARM
- 10-year ARM (non-IO)
- VA adjustable-rate mortgage
- FHA adjustable-rate mortgage
Interest-only adjustable-rate mortgages
Aren’t 10/1 interest-only loans “bad”?
If you watched the news back in 2008 and 2009, when the housing market collapsed, you probably heard a lot about adjustable-rate and interest-only mortgages.
Back then, news programs featured homeowners who felt like they’d been tricked, homeowners who signed up for a low rate and affordable payment only to be shocked when their ARM adjusted and its payments increased.
If you get a 10/1 interest-only ARM, know that your loan’s payment and its rate will change in 10 years. Use the initial low payments for a purpose, and then sell or refinance out of the loan if you don’t want to pay the higher payments later.
When they’re used as designed, 10/1 interest-only ARMs aren’t bad. In fact, they can be just the loan you need to achieve a goal.
10/1 interest-only mortgage FAQ
An interest-only loan can buy or refinance a home just like a conventional or government-backed loan would. But unlike traditional financing, the interest-only loan’s principal would stay the same as you pay only interest on the balance for a set period.
An interest-only loan’s payment will increase after its interest-only period ends. The payment will increase because the lender will start adding principal into the payment. But the payment could also increase because the loan’s interest rate will adjust when the interest-only period ends. The loan’s new rate will depend on market conditions at the time of the adjustment.
Is a 10/1 interest-only loan right for you?
Not every home buyer should use interest-only financing. Home buyers who think they might stay in the loan for decades should get a traditional, 20- or 30-year fixed-rate loan.
But if you’re buying a home for the short term and you want the lowest-possible payment, give this kind of financing a closer look.
An interest-only loan’s lower monthly payments could help you get ahead in other areas of your financial life.See if you qualify for a 10/1 interest-only ARM.