Interest-Only to Repayment Payment Shock Calculator

Understanding the interest-only payment shock calculator — concept and principle

Many mortgages and investment loans start with an interest-only period and then switch to full repayments. The switch can raise the monthly payment sharply, which lenders and regulators call payment shock. This calculator shows the payment during the interest-only years, the payment once principal repayments begin, the size of the jump, the payment you would have had by amortizing from the start, and the extra interest the interest-only period costs.

How it is calculated

With loan P, monthly rate i = annual rate ÷ 12, total term Y years and interest-only period k years:

• Interest-only payment a₁ = P × i
• Payment after the IO period a₂ = P × i ÷ (1 − (1 + i)^(−(Y − k) × 12))
• Amortizing from day one a₀ = the same formula over Y × 12 months
• Payment jump = a₂ − a₁, and as a percentage a₂ ÷ a₁ − 1
• Extra interest = (a₁ × 12k + a₂ × 12(Y − k)) − a₀ × 12Y

The principle

During the interest-only years the balance stays at the full amount. When repayments start, the whole principal must be repaid over the remaining term, which is shorter than the original one. Squeezing the same principal into fewer months raises the payment, and the payment now also includes principal on top of the interest. Because the balance stayed high for longer, more interest is paid in total than on a loan that amortized from the first month.

Worked example

1. Loan $300,000, 6% a year, 30-year term, first 3 years interest only; i = 0.005.
2. Interest-only payment = 300,000 × 0.005 = $1,500.00.
3. After year 3 the loan is repaid over 27 years (324 months): a₂ ≈ $1,871.96.
4. Jump = 1,871.96 − 1,500.00 = $371.96, about +25%.
5. Amortizing over 30 years from the start would cost $1,798.65 a month.
6. Extra interest = 1,500 × 36 + 1,871.96 × 324 − 1,798.65 × 360 ≈ $12,999.20.

How to read the result

The longer the interest-only period relative to the term, the bigger the jump. Check that the post-switch payment fits your budget today, not only after expected pay rises. If it does not, plan for it: save the difference during the IO years or make voluntary principal payments. If rates rise in the meantime on a variable loan, the jump will be larger than shown.

Common mistakes

• Budgeting with the interest-only payment as if it were permanent.
• Comparing the new payment with the IO payment instead of with a normal loan.
• Ignoring rate changes at the switch date.

Frequently asked questions

Why does the payment rise so much?

You start paying principal, and you repay it over fewer years than the original term.

How can I soften the shock?

Pay some principal during the IO period, choose a shorter IO period, or refinance before the switch if better terms are available.

Is the extra interest large?

Here it is about $13,000 over 30 years; it grows with the IO period and the rate.

Sources: Standard time value of money mathematics (amortizing loan payment) · U.S. Consumer Financial Protection Bureau, information on interest-only mortgages