Interest-Only Mortgages

Interest-only mortgages offer the opportunity to take on a big loan for small monthly payments over a designated number of years. Such loans can be helpful or attractive if you anticipate a jump in your income sometime in the near future but, at the moment, are feeling a bit strapped. An interest only mortgage works well when the borrower’s income fluctuates. The flexibility then that an interest only loan provides can seem like a very good and rewarding decision. Essentially, it enables one to buy more house than they can afford at the time of the purchase.

Interest-only mortgages are set-up in two parts. The first is an interest-only period which can last anywhere from 2 to 10 years. The second part is a principal and interest period for the remainder of the loan.  Once the interest-only period ends, the remaining balance amortizes over what’s left of the term. So, when compared to a traditional 30-year mortgage for example, where you have the same principal and interest payment every month, a 30-year loan with a 10-year interest-only option will be characterized by low monthly payments for the first 10 years, followed by significantly higher amounts over the final 20.

Of course, the major attraction of an interest-only mortgage loan is that it keeps more cash in your pocket now. Yet, it’s important to remember, nothing will be accumulating towards the equity of your home. The arrangement is fairly similar to renting, except that the interest may be tax deductible. In addition, another frightening possibility, and one that has plagued many people who baught a home during a the past 5 years,  is that if the value of your home actually drops, you could end up owing the bank more than your house is worth.

At the end of the interest-only period, your payments will go up significantly. If you’re not able to afford those higher payments at that time, you'll need to refinance. You could then, of course, choose a traditional loan or another interest-only mortgage. Remember, however, though that another interest-only home loan will only further delay the building up of equity in your house. And, if you're unable to get a loan at this point, the bank can foreclose and you would lose your house.