About Interest-Only Mortgages

Category : Mortgages

An interest only mortgage loan is a type of home loan wherein the monthly payments do not include repayment of the principle balance. Instead, monthly payments reduce the interest owed on the loan, and the principle balance doesn't decrease.

This type of loan is ideal for home buyers who need to keep their initial mortgage payments low. This increases their buying power, and they're able to qualify for a larger home loan.

Interest only mortgage loans are advantageous for several reasons.
Some home buyers live in expensive housing markets. Thus, they're unable to find an affordable property. With an interest only home loan, these buyers can apply for a mortgage and enjoy low payments during the interest only period.

Borrowers can take advantage of the monthly savings and start a savings account. Because payments are reduced, home buyers typically qualify for a larger mortgage loan. This enables them to purchase a bigger home. What's more, interest only mortgage payments are tax deductible.

While beneficial, interest only mortgage loans are dangerous.
Low monthly payments are temporary and once the interest only period ends, borrowers can expect their monthly mortgage payments to rise. Some home buyers don't prepare for rising payments and they experience payment shock.

For this reason, interest only mortgage loans are only ideal for home buyers who are able to afford a higher mortgage payment in the future. Individuals who doubt their ability to manage a higher payment should not apply for this type of loan.

Interest only periods vary.
The average interest only period on a 30 or 40-year mortgage is 5 years. Thus, borrowers enjoy a reduced payment for the first 5 years of the home loan. Afterwords, the interest rate adjusts and the mortgage fully amortizes (reduction of principle and interest).

When this happens, mortgage payments can increase by $300 or $400, sometimes more. However, home buyers can also choose a shorter interest only period, perhaps 3 years or extend the interest only period to 10 years.

Because interest only mortgage loans are risky, home buyers should consider other alternatives.

Talk with a mortgage broker or lender and inquire about community or special home loan programs that feature low interest rates.

Additionally, saving for a down payment reduces the amount financed and helps lower monthly payments.

Rather than obtain a risky interest only mortgage to purchase a larger home, choose a fixed rate mortgage, buy a cheaper property and upgrade once you've built equity.