Interest Only Mortgage Loans

What are Interest Only Loans?

Interest only mortgage loans are loans where you pay the interest each month for a set amount of time. At the end of that amount of time (usually 5-7 years) people with interest only mortgage loans can refinance, pay the full amount they owe, or start paying off the principal balance.

Basically, interest only mortgage loans gamble that a house will increase in value substantially over five to seven years, or that the owner will receive a large sum of money to pay down the principle. In some housing markets, proerty values may increase dramatically. In others, the housing market has slowed, and many homes will not be going up as quickly in value or may even decrease in value.

Refinancing

Refinancing is taking on a new loan to pay off an old loan. Generally, refinancing is done to lock in a lower interest rate or transform equity into useable cash. It’s a great option if interest rates are lower than what you’re paying and if your house has gone up in value. However, when homes are not going up in value as quickly as they once were, and interest rates climb, refinancing may not be an option for you when your interest only loan expires.

Paying the Full Amount

If you’ve just come into an inheritance, won the lottery, or received a huge raise since you started your interest only mortgage, this is a great option. Additionally, if you have made a large sum of money through investments or the stock market, you can cash those out to pay the full amount. But statistically, this doesn’t happen to very many people, especially when interest rates climb and home values stabilize. If you are stretching to make your home payments, it is unlikely you will be able to pay the full amount when your interest only mortgage loan expires.

Start Paying the Principal

After five to seven years, if you can’t refinance or pay the full amount, you will have to start paying down the principal along with the interest. Up to this point, if you have an interest only loan, you have only been paying the interest on that loan. In other words, all of the sudden, your monthly payments may skyrocket. If your salary has gone up substantially in the five to seven years, this may not be an issue. But for many families, the sudden increase puts a substantial strain on their finances.

Who Should Get an Interest Only Mortgage Loan?

• People who are confident their income will substantially increase in five to seven years.
• People who invest the money they would be spending on principal in money-earning investments.
• Someone whose income consists of infrequent payments like bonuses or infrequent commissions.

What are Some of the Risks of Interest Only Loans?

• Your house goes down in value, making refinancing impossible and requiring you to pay money on something that’s worth less than you have to pay on it.
• Interest rates go up, making refinancing impossible.
• You do not have enough of an income to pay the combined principal and interest payments.

In Conclusion

No matter what your bank or credit union may say, interest only loans are not for families struggling to make their house payments or to buy bigger, better homes. In certain circumstances, they can be a good financial choice, but you should carefully consider the consequences before signing such a mortgage.