Is an "Interest Only Mortgage" right for you?

By Alan Jason Smith

If you have the option of paying only the interest every month on your loan it is called an interest-only loan (or mortgage). This type of loan allows you to pay on the principal balance only when you want to or when it is convenient for you.

Most interest-only loans or mortgages limit the option to pay the interest only for a specific amount of time, (you can't put off paying the principal forever) usually from 5 to 10 years. The remaining principal balance comes due at the end of that term.

Interest-only mortgages may be a good choice for certain borrowers like those whose incomes fluctuate from month to month.

However, this feature of Interest-only loans and mortgages can be either a benefit or a pitfall for borrowers. You must be disciplined enough to pay the principal even though you are not required to do so.

For those borrowers who expect their income to increase during the term of the loan may consider loans with Interest Only options but it is often difficult to start paying the principle if you are not in the habit of doing so.

First time homebuyers may also benefit from Interest Only loans, if they expect to upgrade from their starter home to a bigger home soon. [But they will not have built up as much equity to use toward the second home]

Another advantage of interest-only loans is that they require lower initial payments, which means borrowers can qualify for larger loan amounts than loans without interest-only options. [But this can also be the major disadvantage by allowing you to get in over your head too easily. ]

Is your home going to be your top priority investment, or do you want more cash to direct to other investments that offer higher returns? If you invest in stocks or your own business, and interest-only loan might be the right option for you. Just make sure your investments are yielding a higher return than the interest rate on your Interest Only loan.

Are you expecting to resell your home during the term of the Interest Only mortgage for a profit? Is the market you are looking to buy in rapidly appreciating? If so, an interest-only loan might be the right choice for you.

Interest only loans do carry higher risks, and borrowers must understand these risks.

• What if you do not see the increase in income you expected?
• What if you cannot sell your home later for a profit, or what if the market does not appreciate as much as you expected?
• What if the market depreciates?

There are dishonest lenders out there, and they often deceive borrowers when it comes to interest-only loans.

Because the monthly payment is less, a common deception is that the interest rate on an Interest Only mortgage is lower than the interest rate on loans without an interest-only option.

This is not the case. Interest Only loans carry higher risks for the lender, so they always carry higher interest rates.

Dishonest lenders sometimes deceive borrowers into thinking that they can avoid buying mortgage insurance by choosing an interest-only loan. Again, because Interest Only loans are high-risk for the lender, the borrower is always required to carry mortgage insurance. [Note: Higher Risk for the Lender also means Higher risk for you!- editor]

Comparing different types of loans is the most important step in choosing the best loan for you. Every situation is unique, and understanding how loans are structured will help you make the right decision. Identify your goals, and you will be able to identify the right loan to help you reach them.

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