Interest-Only Mortgages - Are they for you?

Over the past few years, interest-only mortgages have become much more popular. An interest-only mortgage is one where the required monthly payment only covers the interest payment on the loan. With a traditional mortgage, part of the required payment is for interest and part of the payment is to reduce the principal amount of the loan – called amortization. With an interest-only loan, the loan amount will not go down (amortize) unless the borrower chooses to pay additional money with their payments.

Usually, the mortgage requires interest-only payments for a set period of time – 5 or 10 years. Then, the loan converts to a fully-amortizing loan over the remainder of the term of the loan.

There are many reasons that people may opt for an interest only loan. Many borrowers may need the lower, interest-only payments to be able to afford the home they want. This can be a good option for those borrowers who anticipate an increase in their income in the near future. They are able to afford the home they want now and, when the loan converts to a fully-amortizing loan, their income has increased so they can cover the higher payment.

Another reason for an interest-only loan is cash flow. Many real estate investors will use an interest-only loan in order to maximize the cash flow they receive from their rents. With a lower interest-only payment, the investors will have more money to work with each month.

Many people also choose this option so they have more money left over to pay down higher-interest debt such as credit cards and auto loans or to invest in hopes of earning a higher rate of return than the interest rate on their mortgage.

Some people feel that interest-only loans are dangerous. And, they can be. But so can any mortgage program if the borrower is not fully educated on the features, benefits, and possible problems with a loan program. There are several benefits to this program which were listed above. But, borrowers must understand that, if they do not make more than the interest-only payment, the balance of their mortgage will remain the same. When home values are rapidly increasing this is usually not a problem. But, if home values remain flat or decline, borrowers may find themselves with little to no equity in their properties.

If you’re interested in an interest-only loan, make sure your loan officer takes the time to fully explain this program and make sure you are comfortable with all the facets of the program before you sign.

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