Interest Only Loan Calculator

What is an Interest Only Loan?

An interest-only loan is a type of loan where the borrower only pays the interest on the principal balance for a set period, typically 5 to 10 years. During this time, the principal balance remains unchanged. After the interest-only period ends, the loan often converts to a standard principal-and-interest loan.

The Formula for Interest Only Loan Payments

The monthly payment for an interest-only loan is calculated using the following formula:

\[P = L \times \frac{r}{12}\]

Where:

• \(P\) = Monthly Payment
• \(L\) = Loan Amount (Principal)
• \(r\) = Annual Interest Rate (as a decimal)

Step-by-Step Calculation

1. Convert the annual interest rate to a decimal: \[r = \frac{\text{Annual Interest Rate}}{100}\]
2. Calculate the monthly interest rate: \[r_{monthly} = \frac{r}{12}\]
3. Apply the formula: \[P = L \times r_{monthly}\]

Example Calculation

Let's calculate the monthly payment for an interest-only loan with the following terms:

• Loan Amount: $200,000
• Annual Interest Rate: 4.5%

1. \(r = 4.5\% = 0.045\)
2. \(r_{monthly} = \frac{0.045}{12} = 0.00375\)
3. \(P = 200,000 \times 0.00375 = 750\)

The monthly interest-only payment would be $750.

Visual Representation

This diagram represents the loan composition over time. The red portion shows the principal, which remains constant in an interest-only loan. The gray portion represents the cumulative interest paid, which increases over time.