Interest-Only MortgageIf youíve been looking for a way to purchase a home, you know that there are many different kinds of mortgages. There are fixed rate and adjustable rate, VA and FHA, just to name a few. There is also the interest-only mortgage, a type of mortgage that was popular in the 1920s and has been gaining popularity recently.
What is an interest-only mortgage?An interest-only mortgage is a home loan that allows you to pay only the interest for a certain amount of time, usually the first 5 years, sometimes up to 15. You do not pay anything towards the principal during that time. When the designated interest-only period ends, monthly payments toward principal and interest begin. These may have a fixed or adjustable interest rate.
What are the advantages of an interest-only mortgage?The main advantages of an interest-only mortgage are:
- Lower monthly payments than on other mortgages.
- Allows you to buy a more expensive home.
- Gives borrowers flexibility on how they use their money.
- Option of paying more each month to reduce principal.
- May build equity if home value rise.
Disadvantages to Interest-Only Mortgages
- You usually donít build up equity during the interest-only period.
- Minimum monthly payment rises substantially at the end of the agreed interest-only period.
People who would benefit from an interest-only mortgage:
- Borrowers who have the money to pay a traditional mortgage but who have a strong investment for the cash they save by not paying principal.
- Borrowers looking for the lowest possible monthly payment.
- Borrowers whose main income is infrequent bonuses or commissions.
- People who expect to greatly increase their income within a few years. Interest-only mortgages have historically been more common among lawyers and doctors just beginning a lucrative practice who want to pay down higher-interest educational debt before tackling a mortgage.
People who would not benefit from interest-only mortgages:
- Low or moderate income borrowers.
- Regular wage earners who do not have a set plan for investment.
Are there risks associated with interest-only mortgages?The essential risk is that you will end up losing money on the deal and may even be unable to make the higher payments after the initial period. There are two basic ways this can happen.
- Your house may lose value during the interest-only payment period. In that case, you likely would have gained nothing from your financial risk even if any investment you made with the saved principal paid off.
- You may not have the money for the higher payments after the initial period: you could lose your job, become disabled, your investment might sour, or you could incur unexpected expenses.
How do you apply for an interest-only mortgage?There are many lenders offering many different interest-only loans, so you can check with your financial institution. However, you may do better using a mortgage broker like Countrywide or Wells Fargo. The broker will search among various lenders to find the best loan for you.
Financial specialists say that for someone who can reliably expect his or her income to increase substantially, an interest-only mortgage can be a great way to maximize income. However, if you're not that person, better play it safe with a more traditional fixed-rate mortgage, or possibly an adjustable rate mortgage (ARM).