Why Choose an Interest-Only Mortgage?
You’ve heard the word before, interest-only mortgage. The term has been tossed around until everyone knows the words, but the meaning has become a little murky. An interest-only mortgage can be a great thing for borrowers, but why? Who should get them? What’s the difference between and interest-only mortgage and a traditional mortgage? Let’s dig into what an interest-only mortgage is, why someone would want one and who should actually get them.
An interest-only mortgage is a loan which in which the interest is paid off first, before the principle is paid. If an interest-only mortgage is chosen, the borrower and lender agree on a specified time period, usually five to ten years, during which only the interest is paid. The principal amount of the loan is not reduced by these payments. They borrower has the right to pay more than the interest if they wish too, but it is not required under these terms. This results in lower initial payments for the borrower, sometimes by a substantial amount.
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A traditional mortgage is called a “fully amortized mortgage” and payments consist of both interest payments and money directed towards the principle loan amount. These payments are higher than in interest-only mortgages, but the principle amount is reduced much more quickly. Assuming the interest rate stays the same during the life of the loan, a traditional mortgage maintains the amount of the original payment for the life of the loan, while an interest-only mortgage increases in payment size after the initial interest paying period.
Who should get an interest-only mortgage? Anyone with a legitimate need for lower initial payments; they must be prepared to deal with the consequences of choosing this type of mortgage, however. While it is true that an interest-only loan will save you money, that is only the case in the first part of the loan. Since the payments increase after the interest is paid off, the benefits are only applicable for the first part of the life of the loan.
An interest only loan is great for buyers who expect to have a windfall before the loan goes to principle. Borrowers with fluctuating incomes find interest-only loans attractive as well; when income is high, they can pay over the amount and reduce the principle but during low income periods they only have to pay the lower, interest-only payment. Buyers interested in skipping the ‘starter house’ and jumping straight to the house they will eventually need find this type of loan attractive since it can ease the strain of buying a more expensive home. Many homeowners invest the extra money they save every month, putting the money into investments that will pay off before the loan payment increases. In this way they save money through the life of the loan.
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An interest-only loan is not for everyone. Borrowers should examine any interest-only loan for actual benefits; don’t take out an interest-only mortgage if the only difference between that and a traditional mortgage is the interest-only aspect. Look for benefits like reduced future payments after a large mortgage payment and watch for deceptions like “lower interest rates” that are usually not true.
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