Benefits of an Interest Only Mortgage
An interest only mortgage is a loan where you pay only the interest each month, unlike in conventional mortgages, where the scheduled payment comprises both the interest and the principal. You have the option of paying over the interest if you so wish, this will go towards your principle balance. The loan may be given on commercial or residential property.
An interest only mortgage comes with its own set of benefits and pitfalls. Here is a discussion of the former.
Lower Payment
The main advantage of such a loan is that you have lower monthly installments to worry about. An interest only loan can also include property tax, mortgage insurance and property insurance which are all separate costs linked with property ownership and the loan.
Higher Loan Amount
This type of loan allows you to buy a more expensive property without having to make high monthly payments. With smaller monthly obligations, you can free up money and divert it towards more pressing needs.
Option to Customize Your Amortization Schedule
Many lenders allow you to create a custom amortization schedule. For instance, you may choose to make payments against the principal. In this case, your payments in the following months will be lower as the principal amount on which the interest is being paid, would have decreased. Your lender can also offer the flexibility to design a payment schedule that allows you to pay off the loan sooner.
A Good Option for People with Variable Income
Interest-only mortgages work well for people involved in commission-based work or having a variable income. Larger payments can be made against the principal when borrowers have extra cash at a future date. Until then, they only need to make a smaller monthly payment.
Who are Interest-Only Loans For?
This type of loan is suitable for people who are expecting a higher income in the future, an inheritance or financial windfall. Examine your situation and determine if you can pay down the balance without much trouble. The target audience for interest-only mortgages comprises practiced investors confident of (and having experience) investing in stocks and other financial instruments that will generate profits. The principal payment that they would have otherwise paid on standard fixed or ARM 30-year mortgages are diverted towards investments.
What to Keep in Mind
Interest-only mortgage are not without their drawbacks. Borrowers have to keep in mind that the payment of only the interest means that the mortgage balance is not paid down, rather it will remain the same until the full interest only payment is made. For instance, if you have a $30,000 mortgage and make interest only payments for the next 30 years, you will still owe the lender $30,000 dollars. If yours is an adjustable rate mortgage, a rising rate can prove risky.
You have to be disciplined to pay any extra money you may have towards principal payments or save or invest the extra money instead of spending it. There is also the risk that anticipated income growth could fall short of expectations. Sometimes, an interest only mortgage is availed as a short-term investment with the hope that the value of the home/property will appreciate rapidly. This approach can be very risky if the prices do not shoot up or if the borrower is not in a position to keep the house for a long time.
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