Hi, my name is Mandy Dunn and I am a finance expert. In this article, I want to explain the basics of interest only mortgages so that you can make an informed decision on whether this type of mortgage is right for you.
The Problem with Interest Only Mortgages
Interest only mortgages can be risky for homeowners because they only require the borrower to pay the interest on the loan for a set period of time. This means that the borrower is not paying down the principal balance of the loan and is not building equity in their home. When the interest only period ends, the borrower will have to start paying both principal and interest, which can lead to a significant increase in monthly payments. Additionally, if the value of the home decreases, the borrower may owe more on the loan than the home is worth.
Solving the Problem: Alternatives to Interest Only Mortgages
One alternative to interest only mortgages is a fixed-rate mortgage, which offers a stable interest rate and predictable monthly payments. Another option is an adjustable-rate mortgage, which has a lower initial interest rate than a fixed-rate mortgage but can change over time. It's important to carefully consider your financial situation and long-term goals when choosing a mortgage.
What is an Interest Only Mortgage?
An interest only mortgage is a type of loan that allows borrowers to pay only the interest on the loan for a set period of time, typically 5-10 years. After this period, the borrower will have to start paying both principal and interest on the loan.
Who is an Interest Only Mortgage Right For?
Interest only mortgages may be suitable for borrowers who have irregular income, such as commission-based or self-employed individuals. They may also be appropriate for borrowers who plan to sell their home before the interest only period ends or who have other investments that will allow them to pay off the loan at the end of the interest only period.
What are the Risks of Interest Only Mortgages?
The main risk of interest only mortgages is that borrowers are not paying down the principal balance of the loan, which means they are not building equity in their home. Additionally, if the value of the home decreases, the borrower may owe more on the loan than the home is worth. When the interest only period ends, the borrower will have to start paying both principal and interest, which can lead to a significant increase in monthly payments.
Can I Refinance an Interest Only Mortgage?
Yes, borrowers may be able to refinance an interest only mortgage into a different type of loan, such as a fixed-rate or adjustable-rate mortgage. However, it's important to carefully consider the costs and benefits of refinancing before making a decision.
What Happens if I Can't Make the Payments on my Interest Only Mortgage?
If you are unable to make the payments on your interest only mortgage, you may be at risk of foreclosure. It's important to discuss your options with your lender as soon as possible if you are experiencing financial difficulty.
How Long Can I Have an Interest Only Mortgage?
The length of the interest only period will depend on the terms of your loan agreement, but it typically ranges from 5-10 years.
What Happens at the End of the Interest Only Period?
At the end of the interest only period, the borrower will have to start paying both principal and interest on the loan. This can lead to a significant increase in monthly payments.
The Pros of Interest Only Mortgages
The main advantage of interest only mortgages is that they offer lower monthly payments during the interest only period, which can be beneficial for borrowers with irregular income or other financial obligations. Additionally, borrowers may be able to invest the money they save on monthly payments into other investments, such as stocks or mutual funds.
Tips for Choosing the Right Mortgage
When choosing a mortgage, it's important to consider your financial situation and long-term goals. Look for a mortgage with a competitive interest rate, predictable monthly payments, and favorable terms. Consider working with a reputable lender or mortgage broker who can help guide you through the process.
Summary
Interest only mortgages can be a risky option for homeowners because they do not build equity in the home and can lead to higher monthly payments when the interest only period ends. It's important to carefully consider your financial situation and long-term goals when choosing a mortgage and to explore alternatives to interest only mortgages, such as fixed-rate or adjustable-rate mortgages.