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, at the end of your mortgage term you will only have paid off the interest.
This will leave you with the original home-loan amount yet to be repaid; the entire debt would have been settled if a capital mortgage repayment had been taken out instead.
Put simply, an interest only home mortgage doesn’t contain principal. The most common of these loans don’t allow a borrower to make interest-only payments for their entire period, rather this provision is only made good for the initial five or ten years. After this time the loan is amortized, i.e., the payments are increased to an amortized amount but the loan balance remains as it was.
1Definition of an Interest Only Home Mortgage
A mortgage is described as being ‘interest-only’ if the scheduled monthly mortgage payments that the borrower is meant to make just involve interest. The period within which these interest-only payments can be made is specified and is usually between five and ten years. As a borrower you can pay in excess of the interest if you wish to. If you make use of the interest-only option for each month of the interest-only period, your payment won’t feature any repayment of principal. This implies that your loan balance will remain unaltered.
2Who Should Take Advantage of Interest Only Home Loans?
An interest only home mortgage will suit you if you have a viable reason(s) why you prefer the lower payments initially required and if you are adequately prepared to handle the consequences of choosing this option. Some of the reasons that might prompt you to choose an interest only mortgage are as follows:
- Make principal payments when convenient – You can take advantage of this payment structure when your finances are quite restrictive. As soon as you are in a better financial position you can decide to reduce the principal amount by a substantial amount. You need financial discipline to go this way.
- 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 materialize.
- Make cash flow investments – Rather than building wealth by paying your mortgage debt you can instead invest your excess cash flow and manage 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.
3Watch Out for these 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 for any two identical mortgages A and B that only differ because B has an interest only option, B will be considered to be riskier by lenders. This is because after the lapse of any period, B is the one that’ll still have a larger balance. Since B is riskier, it naturally has to have 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 but the period for which the initial rate applies isn’t specified and it can be as long as five years or as brief as a month.
4What To Do Once You Have an Interest Only Home Mortgage...
With this type of loan you should do some arithmetic so as to find out whether you can revert to a repayment mortgage. This can be done with the use of an online mortgage calculator. If this is a possibility but can only be done after you pay early repayment charges for shifting, you can accumulate this required amount by making savings in a high-interest account. When shifting isn’t possible you can approach the lender for a part-interest-only-part-repayment-loan which 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.
More information is available at http://www.mtgprofessor.com/Tutorials2/interest_only.htm.
