Interest Only Mortgages

Interest only mortgages became extremely popular during the early 2000’s when the economy was booming and housing prices were rising higher with every passing week. With the prices of homes consistently going up, an interest only mortgage seemed to be the only way to afford the home you wanted.

In parts of the country where the housing prices were extremely high, such as the Northeastern USA and in California, interest only mortgages were exceptionally appealing as it seemed to be the only option for home ownership.

The details of an interest only mortgage are pretty simple. Basically, you pay only the interest on your loan at an interest rate which will be fixed for about five to seven years. At the end of that period, you may still be able to pay interest only if you prefer, however, the interest rate will adjust annually to whatever the standard interest rate is at that time.

At the end of your interest only period, another option would be to refinance your interest only mortgage in favor of a standard mortgage, paying both interest and principal.

One of the risks of interest only mortgages is that you will not be building any equity in your home.  If the real estate market is good and the price of homes is rising, this may not be an issue as you will be gaining equity from the rise in value of your home.

On the other hand, if the real estate market is in a downward spiral, you may find that you will not be able to refinance at the end of the interest only period if the value of your home has dropped. This is the exact scenario which has unfortunately affected a lot of people in the US over the past few years.

Even if your home’s value has remained stable, who’s to say that you will be able to afford the higher monthly payments when it comes time to refinance into a standard mortgage?

Interest only mortgages are not advisable in most situations. However, under the right circumstances, it can actually work out, especially if you expect your income to increase before the payments do.

This is an option that a medical student might choose. Paying interest only keeps their payment lower while they are still in school. After they graduate, they know their salary will be enough to cover the entire payment including principal, interest, taxes and insurance.

Maybe you’re a first time business owner who needs the cash to build your business. You may choose this option because you’re sure that in a couple of years your business will be bringing in enough cash for you to afford the rise in payments.

You may also benefit from an interest only mortgage if your income consists of mostly bonuses and commissions, like executives or those in sales. When things are not looking so good, the low payments can really help them make it until they receive their bonuses and commissions. Once they receive them, they will be able to pay extra amounts toward the principal.

Also, by choosing this option, the money that you save can be invested. This is what some people do when they’re sure that the returns on their investments are going to pay off.

However, sometime investments don’t work out the way we expect and in this case you could get yourself into a world of trouble.

Whether these situations apply to you or not, you should be careful and consider all of your options before opting for an interest only mortgage. While that beautiful home of your dreams may be calling your name, if you miscalculate, the whole process could turn into your biggest nightmare.