That’s why we’ve laid out the basics as well as some of the dangers involved for you. And of course, if you're still somewhat hazy as to whether an interest-only
mortgage is right for you, give us a call at 1-800-734-REFI. We'll make everything
crystal clear.
The Basics
A mortgage is "interest only" if the scheduled monthly mortgage payment
– the payment you would be required to make – consists solely of interest.
The option to pay in this manner usually only lasts for a certain period, typically
five to 10 years, depending on the loan. But, of course, you always have the right
to pay more than just the interest if you want to, which would be applied to principal.
However, if you were to just pay the interest amount every month during the interest-only
period, your payment wouldn’t include any repayment of principal. The result:
your actual loan balance would remain unchanged.
The Upside Of An Interest-Only Mortgage
Interest-only mortgages are typically for people who have a real use or need for
a lower initial payment and are fully prepared to deal with the loan’s requirements
down the road. If you’re in the right situation, interest-only mortgages can
offer you a lot of savings and flexibility.
- Pay Principal When Convenient: If you have a fluctuating income,
you may really like the flexibility an interest-only mortgage can provide. When
money is tight, you can make the interest-only payment and when you have some extra
cash, you can pay down some principal.
The important question you must answer is whether you are disciplined enough to
make the payment to principal even when you don’t have to.
- Ability To Buy More House: This is a very common use for an interest-only
mortgage. The lower monthly payment allows you to get into a house that you would
otherwise not be able to afford.
Here, you must be ok knowing that the loan’s terms won’t change even
if that promotion or raise you were promised don’t come through.
- Invest the Cash Flow: You might be savvy enough to be able to build
wealth or fund accounts like your 401k more rapidly by investing excess cash flow
rather than paying down your mortgage and building equity. For this to succeed,
however, your return on investment must exceed the mortgage interest rate, since
that rate is what you earn when they repay their mortgage.
You must be honest with yourself whether you’d really have the commitment
to investing your excess cash flow and whether you truly believe that your investments
will yield a return higher than the mortgage rate.
- Quick Capital Gain Or “Flipping”: An interest-only
mortgage is an excellent choice in a quick turnover where you plan on buying the
house then renovating and selling it as soon as possible. The interest-only mortgage
option lowers the required initial payment allowing you to maximize your overall
return when you sell the house.
However, more than just the type of loan, this is a very risky endeavor in a “down”
real estate market. In order to offset the risk, you absolutely must be sure that
the home will sell after rehabilitation, regardless of what type of loan you choose.
- Pay-down A Second Mortgage: If you have a second mortgage, home
equity loan or home equity line of credit (HELOC) with a higher interest rate (or
an adjustable rate), then you could use the savings from an interest-only mortgage
to pay it down. This makes sense because of the higher rate on the second mortgage
and the possibility of future rate increases.
The Fine Details
Depending on your situation, the possible downside of an interest-only mortgage
may outweigh the good that it can provide. Read through the potential cons of an
interest-only mortgage to truly understand if one is right for you.
- Rising Monthly Payments. The interest-only payment period usually
only lasts between three and 10 years. After that, your monthly payment will increase
– even if interest rates stay the same – because you must pay back principal
in addition to interest. So, it’s risky to focus only on your ability to make
interest-only payments, because at some point, that will be only a portion of your
monthly payment. And when this happens, the payment could increase a lot.
If payment shock were to become a problem, then simply refinancing your mortgage
could be a solution. However, no one can predict the future of interest rates three,
five or 10 years down the road. Plus, if your loan balance is greater than the value
of your home, you may not be able to refinance anyway.
- Prepayment Penalties. Some interest-only mortgages have prepayment
penalties. If this were the case, you could owe additional fees or a penalty if
you were to refinance your loan during the prepayment penalty period. The good news
is that most interest-only mortgages let you make penalty-free, additional principal
payments with your monthly payment.
- Falling Housing Prices. Especially in housing markets where depreciation
is very common, a non-equity-building interest-only mortgage could double your risk
of owing more on your mortgage than what your home is worth. If this is the case,
you may find it very difficult to refinance. And if you decide to sell, you may
owe the lender more than the amount you receive from the buyer.
- No Increase In Income. Realize that the future may not hold the
extra money that you hope to be earning. Make sure to take this into account since
what you can afford now as an interest-only payment may be too much when the grace
period ends and principal is added to the equation.
- If No Appreciation, No Equity. With an interest-only mortgage,
if you don’t start paying down the principal owed from the outset and your
house doesn’t appreciate or depreciates, you won’t have any equity in
your home. Or worse yet, you could owe more than the market value of your home.
- Higher Rate. For the most part, you can expect a slightly higher
rate with an interest-only mortgage versus an identical loan with an interest-only
option. This is due to a higher risk factor for the lender because you might not
pay-down any principal on the loan. Ask a loan consultant to compare rates for you.
The Bottom Line
- Interest-only mortgages can be flexible and allow you to make lower monthly payments
during the first few years of the loan. You can repay some of the principal at any
time to help keep future payments lower.
- For a number of reasons, an interest-only mortgage may not be the right choice for
you. Don’t let the attraction of an initial smaller monthly payment lead you
to take out a larger mortgage than you will be able to afford when the interest-only
period ends.
With all this information in your back pocket, you should have a good grasp of whether
an interest-only mortgage is right for you. If not, or if you ready to take the
next step, contact our expert loan consultants at 1-800-734-REFI1-800-734-REFI. We’re here
and ready to help.
