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How Does An Interest Only Mortgage Work?

Interest Only Mortgage

Interest Only mortgages have become popular because the fair market value (FMV) of residential property has increased so significantly. These loans, while potentially dangerous, give some borrowers needed advantages. The most important positive features of these loans:

Buyers with fluctuating monthly income have a “cushion” since only the interest on the loan is due each month.
Buyers wishing to buy “more” house than they could otherwise afford may qualify for the home they want since the monthly payment only requires interest.
Buyers planning on a “quick turnover” of a home can benefit from the better cash flow created by a lower monthly payment.

While these are tempting reasons to consider an Interest Only mortgage loan, you must also weigh the potential negatives before making your selection. Some items to consider:

Mortgage loans, because of the large amount borrowed and the long term for repayment, are all “front loaded”, meaning that most of your monthly payment for the first few years is applied to interest and little to balance reduction. Therefore, unlike an auto or personal loan, paying interest only saves relatively minimal cash each month.
If you do not have the financial discipline to make principal payments whenever you are able, your Interest Only loan balance will never go down nor will your equity increase in your home.
While these loans may start with a market or lower than market interest rate, the Interest Only provision will normally only last five to ten years, not for the life of the loan. You will be required to refinance the loan or begin making normal interest and principal payments in time.

There are some varieties of these loans that may start with a much lower than market interest rate, then increase in “steps” over the first few years. As a qualifying “tool” this product could be very helpful. An asset building tool it is not without your attention to reducing your principal. Examine all of the terms of any Interest Only mortgage loan you consider. Ask for an explanation of any terms that are unclear. An Interest Only loan can be a very useful form of financing, but can also become a source of problems if not properly managed. As with all forms of financing, make sure you understand the terms, analyze your available options, and then make a decision with confidence on the loan you believe works for you. Like dogs (“there are no bad dogs, only bad owners”), there are no bad mortgage loans. But some are better than others for certain situations and different borrowers. An Interest Only loan may or may not work for you. If it does, go for it.

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