Is an Interest-Only Mortgage Right for You?

Purchasing property using an interest only home mortgage is much cheaper because as the borrower it is only the interest that you are paying off and not the capital. However, it is important to understand the details before you enter into this type of an agreement.   Read More

Simply put, an interest only home mortgage doesn’t contain any of the principal balance.

Definition of an Interest Only Home Mortgage

A mortgage is described as being ‘interest-only’ if the scheduled monthly mortgage payments just involve interest.

The period of time when only the interest is included in the payment is usually between five and ten years.

At that point, the monthly payment amount will increase so you can begin to repay the principal balance.

When to Consider an Interest Only Home Loan

An interest only home mortgage will suit benefit you if you have a viable reason(s) as to why you want lower payments in the beginning of the mortgage term.  You must also be prepared to handle the consequences of the increased payments later in the life of the mortgage.

Some of the reasons that might prompt you to choose an interest only mortgage are as follows:

  • Buy a better house – If you anticipate that your income is going to rise, you may want to move into a better, more expensive house; doing so involves substantial moving and transaction costs. Using the interest only mortgage payments you can move into the new house as the costs involved will now be quite manageable. You however need to be quite certain that your anticipated rise of income will occur.
  • Make cash flow investments – Rather than building wealth by paying your mortgage debt you can instead invest your excess cash flow and manage your investments to generate more wealth. This will only be possible if your return on investment exceeds your mortgage interest rate as this rate will be what you could have earned upon repaying the mortgage.
  • Make quick capital gains – An interest only mortgage is very applicable for quick turnover situations where you need to optimize on the worth of house you can buy but are facing income limitations. With this mortgage option your initial required payment will be lower and you’ll thus be able to access larger loan amounts. Making capital gains using an interest only mortgage is however not the best option available to you for such requirements. If a financial crisis follows the rapid capital gain period, your anticipated capital gain will become a massive capital loss.

Interest Only Home Mortgage Risks

Many borrowers have been duped into accepting unsuitable interest only home loans that feature desirable but non-existent features.

The simple rule that will keep you safe in this regard is to remember that if two mortgages are the same, except that one of them is interest only, that mortgage will be considered riskier for lenders.

Since the interest only loan is considered a higher risk, it usually comes with a higher price.

Be wary of these common deceptions:

  • An interest only home mortgage loan attracts a lower interest rate – This ruse stems from the comparison of adjustable rate mortgages and fixed rate mortgages; the former have lower interest rates. Many interest only mortgages are ARMs but those ARMs with interest only options will have lower rates than fixed rate mortgages not because of this option but simply because they are ARMs.
  • With an interest only mortgage you can dodge your mortgage insurance payments – The truth is that for interest only mortgages that don’t feature mortgage insurance from an insurance provider, it is the lender that provides the insurance. As the borrower you pay the premium in your interest rate and not as conventional insurance premium.
  • It is cheaper to amortize an interest only loan – Amortization is done in a similar fashion for interest only loans for which borrowers opt to make fully amortizing payments and for other mortgage plans at the same rate that don’t have the interest only option.
  • The quoted interest rate on ARMs with an interest only option remains fixed for the interest only timeframe – This may or may not be the case; the interest only period is specified and is usually five or ten years.  However, the period for which the initial rate applies may not be specified and it can be as long as five years or as brief as a month.

What To Do Once You Have an Interest Only Home Mortgage

With this type of loan you should do some arithmetic to find out whether you can revert to a repayment mortgage.

In some cases, you will be required to pay a repayment fee.  You can approach the lender for a part-interest-only-part-repayment-loan to cover these fees.  This at least means that you’ll be paying off some of the capital sum. Before taking this option make sure to confirm that your repayment will be the larger split.

Additional information is available at http://www.mtgprofessor.com/Tutorials2/interest_only.htm.

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