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. $r=4.5\mathrm{\%}=0.045$
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.