How Do the Payments Work on an Interest-Only Fixed-Rate Loan?

Payments on interest-only fixed-rate loans begin low but increase at the end of the interest-only period, so the payment begins to cover both interest and principal, according to Bank of America. During the interest-only period, the homeowner is not building equity in the home, which sometimes makes refinancing difficult.

Interest-only fixed-rate mortgages are a non-traditional version of the fixed-rate mortgage, explains Investopedia. However, since they require a payment adjustment at the end of the interest-free period, they defeat one of the advantages of fixed-rate mortgages, which is its equal payments. These loans still face the disadvantages of other fixed-rate mortgages. If the prime interest rate drops, the mortgage payment remains the same. The homeowner could be locked in to an increase in his mortgage payment while friends with adjustable-rate mortgages are enjoying a price reduction when interest rates fall.

Interest-only plans are popular with customers who have fluctuations in income, due to self-employment or bonus schedules, notes Bank of America. It only offers this type of financing on its jumbo loans, as of 2015. Buyers who plan to spend a short amount of time in a home sometimes find them appealing. However, because the buyer is not making any payment toward the principle, selling the home at a profit becomes more difficult.