Interest Only Mortgage

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An interest only mortgage, as the name suggests, allows borrowers to pay interest-only, monthly payments for a specified initial period of the loan, usually 3, 5, 7, or 10 years. An interest only mortgage offers substantially lower payments at the start of the loan than mortgages figured with principal and interest. After the initial interest only mortgage period, the principal balance originally borrowed is due in full with interest amortized over the remaining period of the loan. In general, these loan products are offered as reward programs for borrowers with above average credit ratings.

An interest only mortgage is not a good product for everyone, but it is a great strategy for some. It could be beneficial if your home is in an area that is appreciating at a rapid rate, or you have a sizable amount of equity in your home. Borrower's are taking advantage of introductory lower interest rates and monthly payments to buy more house than they might otherwise afford, or taking the savings and investing in real estate, retirement funds, and college education funds for their children. If you are expecting to earn a larger income in the future to cover increases in future monthly payments, it may be advantageous to elect an interest only mortgage. If you are paid a salary but rely on bonuses or commissions for income, an interest only mortgage can be a great option. You always have the option to make payments toward the principal portion of the loan, so an interest only mortgage can be a great way to pay off a loan in a shorter period of time. If you choose to make a principal payment during the interest only period, this further lowers your interest only mortgage payment the following month. It is wise to make regular contributions to an investment policy or savings account to soften the burden of higher payments once principal and interest are due.

There are also risks involved with an interest only mortgage. As mentioned above, low introductory payments often allow borrowers to purchase more home than they could otherwise afford. After the initial interest only period of the loan, interest rates and monthly payments typically increase dramatically. If you are not prepared for these increases (with some type of savings or investment account or an income increase), it can be difficult to keep up with monthly payments and overextend yourself. In addition, if only making interest-only payments for the initial period of the loan, you are building equity in your home at a much slower rate than if making a fully-amortized principal and interest payment. If you are a salaried employee and do not expect additional income in the future or foresee additional expenses for yourself (such as auto loans or education funds for your children), an interest only mortgage may not be for you.

Advantages Of An Interest Only Mortgage

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• Low introductory interest rate and monthly payment
• You are in an area where homes are appreciating quickly
• You have a lot of equity in your home
• You are paid sporadically, with bonuses or commissions
• You are expecting increases in income in the near future
• You are looking to invest money in property, 401k, money markets, or education funds for your children or save money
• You can buy "more house" than you could with a higher monthly payment
• There are typically no pre-payment penalties tied to interest-only loans
• You have the option of paying down principal at any time during the loan period

Disadvantages Of An Interest Only Mortgage

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• Interest rate and monthly payments will most likely increase after initial interest-only period
• You can overextend yourself if you are unprepared for higher monthly payments
• Your home could lose value
• You are not expecting increased earnings in the future
• You may be tempted to spend the money saved monthly on pampering your lifestyle, rather than investing the money as originally planned
• You will not build equity as quickly as paying a fully amortized principal and interest payment

Types of Interest Only Mortgages

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• 30 Year Fixed Interest Only
• 3/1 Fixed ARM Period Interest Only
• 5/1 Fixed ARM Period Interest Only
• 6 month Adjustable Interest Only
• 1 month Adjustable Interest Only