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What are Interest Only Mortgages?
Interest only mortgages are loans for which the borrower need only pay the interest for a particular term, rather than principal and interest. These types of loans are becoming more popular as the cost of housing skyrockets in some areas of the US, but there are inherent dangers associated with them.
Interest only mortgages are appealing to borrowers because they allow them to purchase a more expensive house than they might otherwise be able to afford. The 'principal free' term of the mortgage can be five to seven years or longer. If you are fairly confident that house prices are going to remain high -- a dangerous assumption to make -- and you are not planning to stay in your house for more than a few years, an interest only mortgage might save you money.
Formerly, interest only mortgages were the province of the very rich, who would take the money they would ordinarily be paying in principal on their loan, invest it in ways that would make more income that they could apply to the principal, and have a little left over for their efforts. But now they are becoming increasingly common among the general home-buying public, and warnings are in order.
If you are just starting out in a career with significant advancement possibilities in the first five or ten years, and you can expect your income to double over this time, an interest only mortgage is probably not very risky. This assumes job stability and a fairly robust economy, of course. If you are in a business with peaks and valleys of income, such as real estate, interest only mortgages might appeal to you because you can pay on the principal as you experience income peaks -- through commissions or bonuses -- and not pay on the principal in the valleys.
First time homeowners are probably not best served by interest only mortgages. The bulk of the mortgage payment during your first few years is mainly interest anyway, so savings can be minimal, and the hard-pressed homebuyer usually isn't investing the savings for later. So if housing prices fall or the homeowner's income suffers reverses, the end of the principal-free term of the loan might mean a sudden inability to make your mortgage payments. As always, consult with a financial advisor before selecting an interest only mortgage.
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![With an interest only mortgage, the borrower pays only interest for a certain term rather than principal and interest.]()
By: nitoWith an interest only mortgage, the borrower pays only interest for a certain term rather than principal and interest. -
![First-time homebuyers are typically best served avoiding interest only mortgages.]()
By: Brian JacksonFirst-time homebuyers are typically best served avoiding interest only mortgages.
Discussion Comments
If this is something you are looking in to, I would make sure you get all the facts and figures and talk to people in the business who will give you good information. Speaking with loan officers and financial planners can help you make the best decision.
There are also many loan calculators online where you can plug in the numbers to give you an idea of what your payments would be based on the figures you input.
I know of some people who took out interest only mortgages on their homes and it did not turn out to be a good thing for them. Although they were able to purchase a beautiful home that they would not have been able to purchase with a fixed rate interest only mortgage, it turned out to be more trouble than it was worth.
With the declining housing market, their homes are not worth nearly as much as they were when they took out the loan. This leaves them in a pretty tough position and the best thing is to try and wait it out and hope the market begins to turn soon.
When I first heard about interest only home mortgages I thought they sounded kind of appealing. Once I really understood how they worked though, I was not willing to use one.
It can be tempting to think about living in a much bigger home, but if the value of the home declines and you don't have any equity in the home, you could be in trouble. This is a risk that I am not willing to take at this point in my life.
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