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Interest Only Mortgages

An interest-only loan is a special type of loan that requires the borrower to only make payments on the interest being charged to the mortgage loan. As a result, the principal balance on the loan remains unpaid until the end of a pre-determined term. The monthly payments for this type of loan are typically calculated by determining how much total interest is due during the pre-determined payment term. This amount is then divided into equal payments so the homebuyer can make a set payment each month.

Paying Them Off

In the most traditional sense, the homebuyer must pay the entire principal balance remaining on the loan once the term has been reached. In many cases, however, the buyer may be able to convert the loan to a more traditional loan that involves paying toward the principal and the interest after the interest term has been reached. When this option is used, the remaining loan balance is said to be fully amortized.

Whether or not this will be an option depends upon the lending institution. Therefore, homebuyers that think they may not be able to pay the principal off when the interest term has been reached should make certain this is an option before taking an interest only mortgage loan. In many cases, homebuyers automatically have these loans set-up to be amortized after the interest-only term period is complete.

Who Should Consider Obtaining Them

Interest only mortgages are not for everybody. Most people interested in this type of loan are not looking for a long term mortgage program. Therefore, they are generally best suited for those people that:

  • Have a high net worth and want to invest their money for a higher return rather than having it tied up in home equity
  • Young professionals, such as doctors or lawyers, that are certain their income will increase dramatically over the next few years but need lower mortgage payments now.
  • People that do not plan to live in the home for a long period of time, so they are more interested in keeping their payments low rather than building up equity.
  • Investors interested in purchasing homes in areas where appreciation is high

These mortgage loans are also attractive to people who want to purchase a more expensive home while keeping their payments down. In areas where the homes are appreciating at a fast rate, taking out an interest only loan is a good way to keep payments low while still earning equity in the home as its value increases.

The Risks Involved

Although a these loan offers a good way to keep payments low for the first few years, the monthly payments increase dramatically once the interest-only term is complete. Therefore, homebuyers wishing to use this option need to be certain they will be able to afford the higher monthly payments at this time. Otherwise, they risk the possibility of losing their homes due to a default in payment. Similarly, if the value of the home actually drops during the term, the homeowner is left paying a loan that is higher than the value of the home. This can make it impossible to get the house refinanced if necessary.