How to Use a Loan Interest Only Calculator to Budget Smarter

Taking out a loan with interest-only payments can seem appealing. Your initial monthly costs are lower, giving you more room in your budget. But interest-only loans come with risks. Using a loan interest only calculator helps you see the full financial impact so you can make a smart borrowing decision.

I’ll explain what an interest only loan is, when this type of financing might make sense, and most importantly – how you can leverage online interest only calculators. Let’s crunch some numbers!

What Is An Interest Only Loan?

With a typical loan, part of your payment goes toward interest and part goes toward paying down the principal (the amount you borrowed). An interest only loan is different:

• You only pay the interest due each month
• The principal loan balance doesn’t decrease over time
• After the interest-only period, you begin making principal + interest payments

Interest only loans come in many forms – mortgages, personal loans, student loans, etc. But they all work the same way.

For example, say you take out a $200,000 interest only mortgage with a 5% rate for the first 10 years. Your monthly payment would be around $833 for those 10 years (5% of $200,000 divided by 12 months).

After year 10, you’d start making standard principal and interest payments of about $1,073 until the loan is paid off Your payment jumps because you need to pay back the original $200,000 principal now.

When Do Interest Only Loans Make Sense?

This unique payment structure isn’t right for everyone. But certain borrowers can benefit from interest only loans in the short term:

• Variable or unpredictable income: Lower payments give you flexibility if your income fluctuates a lot. Once earnings stabilize, you can handle the higher principal + interest payments.

• Invest extra cash flow: An interest only loan frees up money to invest or pay down high rate debt. If your returns outpace the interest rate, you come out ahead.

• Tax deductions: With an interest only mortgage, nearly 100% of your payment is deductible if you itemize. This can provide big tax savings.

• Bridge financing: It can serve as temporary financing while you prepare to refinance or sell the property.

The key is having a plan before your interest only term expires. Know how you’ll afford the higher payments down the road.

How an Interest Only Calculator Works

These online tools make it easy to compare interest only vs traditional loan payments. Here are the steps:

1. Enter your loan amount (like $250,000)

2. Input the interest rate (such as 7%)

3. Select your loan term for interest only payments (for example, 5 years)

4. Choose your full loan term (like 30 years)

Based on this info, the calculator will show:

• Monthly interest only payments
• Monthly principal + interest payments after the interest only period
• Total interest paid over the life of the loan

Let’s try an example:

• Loan amount: $250,000
• Interest rate: 6%
• Interest only term: 10 years
• Full loan term: 30 years

The Interest Only Calculator shows your interest only payment would be around $1,250.

But after 10 years, your payment jumps to $1,432 when you start paying off principal too. And you’d pay $193,596 in total interest charges!

Playing around with different inputs gives you a clearer picture of costs. You can see how extending or shortening the interest only term affects your bottom line.

Other Important Factors

While a loan interest only calculator provides estimates, keep these other key points in mind:

• Your actual interest rate depends on your credit, income, and lender policies. Get personalized rate quotes before borrowing.

• Interest only loans often have stricter approval criteria like higher credit scores or income requirements. Make sure you qualify first.

-Carefully read the terms to understand when the interest only period ends and payments increase. Don’t get caught off guard!

• Factor in taxes if you can deduct interest payments. This lowers your effective costs.

• Compare whether investing any extra cash flow beats the interest rate you’re paying. Crunch the numbers in a detailed investment calculator.

• Have a solid repayment plan before the higher payments kick in.

Smart Strategies for Interest Only Borrowing

Interest only loans aren’t for the faint of heart. Use these tips to mitigate risks if you need this financing option:

• Shop around for the lowest rates – even small rate differences greatly impact your total interest costs. Ask lenders about discounts for enrolling in autopay or having another account relationship.

• Pay extra toward the principal during the interest only years. This reduces the balance when the higher payments start. Even $100 or $200 extra per month makes a difference.

• Set up automatic transfers from your checking account for any extra payments so you don’t forget.

• Recast or refinance the loan before the interest only period ends if possible. This maintains a lower payment long-term.

• Have a plan to increase income or cut expenses when your payment jumps. Maybe you’ll rent out a spare room or no longer pay for daycare by then.

• Use interest only judiciously. Don’t get larger loans just because the payment seems affordable at first. Make sure the amount borrowed aligns with your actual needs.

• Review your budget annually to ensure you can still handle higher payments down the road. Your situation may change.

Do Your Homework Before Borrowing

Interest only loans can be a double-edged sword. Use them strategically and you could win financially. Rely on them as an easy fix without planning ahead and you could get burned.

Running the numbers in a loan interest only calculator provides clarity. See what your budget can truly handle before taking the leap into an interest only loan. Doing your homework avoids nasty surprises!