Interest Only Mortgage

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Lower your monthly mortgage payments by paying only interest - at least for a little while.

What Is an Interest Only Mortgage?

There is really no such thing as an interest only mortgage. As with any loan, you have to pay back the amount borrowed, the principle, as well as payments on the interest. Sounds obvious! Home loan lenders do offer interest only payment options, where the scheduled monthly mortgage payment is just that, interest only. No money is going toward paying down the principle debt.

The option to pay interest usually lasts for a specified period, such five or seven years. After that interest only period, the monthly payment will increase with money going toward the principle included along with payments on the interest in the bill.

Interest only payment options are available for fixed rate mortgages and adjustable rate mortgages.

Are You a Good Candidate for Interest Only Payments?

If you have a very compelling reason for lower payments during the initial period, and you are prepared to handle the higher monthly payments later, interest only payment plans might fit your needs. Here are the top three reasons for considering an interest only payment plan:

Pay Down the Principle When You Can - Paying just the interest is just an option. You can make payments on the principle whenever you want, even in the initial interest only period. If your income fluctuates month to month, and you have the discipline to make a larger payment when you are not contractually obligated to, you could just pay interest one month and pay against the principle the next month when your income is higher. But you must have the will power to send that extra money to the lender even when you don't have to.

Buy a Bigger Starter Home - Buying your first home? Expect your income to rise in a few years? Because interest only payments are lower than payments that include money toward the principle, you can afford a more expensive home with smaller monthly payments. There's no predicting the future. So, you are taking a risk that before the interest only period has ended, your income will have risen to meet the higher monthly bills coming with principle payments included.

Invest Your Money Elsewhere - Are you smart and savvy with your money? Are you very self-disciplined? In theory, you could invest the money that would otherwise go toward paying down the principle of your home in something that yields a higher rate of return than the interest rate of the mortgage. The keys to this strategy are investing the money, and not spending it, and having an investment with a high rate of return.

Risks and Costs

Interest only payment options come with extra costs and more risks.

Higher Interest - If you have the choice between two loans that identical, except one is a standard loan where interest and principle payments are included in each bill, and the second is an interest only plan, the interest only plan is riskier for the bank and more costly for you. Because principle is not being paid down with the interest only plan, the bank is assuming more risk, and will charge a higher interest rate. Over the life of the loan, you will pay significantly more for the home than with a standard loan with a lower interest rate.

Home Price Drop - What happens if you are only paying interest on a house for a few years while the value of that house has declined? You have lost money - or rather value. We have seen a jubilant incline followed by a devastating decline in home values. If you owe exactly the same amount on your home as when you first signed the papers, because you have only been paying interest, and the value of your home has dropped, you now owe more than the house is worth. You could wait it out until home prices rise again, you could sell the property at a loss, or you could just walk away. In any case, without paying down the interest, you are taking a serious risk.

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