What Is An Interest Only Mortgage?

Find out if this is the right type of home loan for you.

An interest only mortgage is exactly what it says. The payment you agree to make will be interest only payments, and nothing will be applied to the principle of the loan balance as long as you continue to make interest only payments.

This option lasts for a specified term, normally 5 or 10 years. As the borrower, you have the choice to pay more than just interest if you so desire. This is also known as an options mortgage.

If you do decide to take advantage of the interest-only payment option each month through the specified term, the payment you make will include nothing towards repayment of the principal. In this scenario, the loan amount remains unchanged. You will still owe the same principal at the end of the term of your interest only mortgage.

An example of an interest only home loan:

Say you borrowed $100,000 with an interest only term of 5 years at 6% interest. Your required payments would be around $500 a month. The end of the 5 years, you would have paid a total of $12,000 in interest and would still owe the entire principal. This means that you have spent all that money and built no equity whatsoever in your property.

In contrast, a fully amortized mortgage would include a payment comprised of interest and principal from the outset. The principal would decrease monthly as you make your payments. Granted you would be paying more on the monthly payment, but you are also making positive progress on the loan amount (principal).

The interest only payments are a viable option for buyers with a fluctuating income over the year. When times are tight, they could choose to make just the interest payment. When finances are better, a payment towards principal would be made. Of course, it is better to pay own the principal at every opportunity. You need to ask yourself whether you have the discipline to pay the higher interest/principal payments even when you are not required to.

When is an interest only mortgage an option?

Some families begin with a "starter" house, then trade up to a larger, more expensive home as their income level rises. The process of trading up carries high associated costs, like those for transactions and moving.

These costs can be avoided by going directly to the larger house now. This will cause a short term cash flow strain, but considering an interest only jumbo mortgage might make it more manageable. The involved risk is that the expected higher income doesn't materialize.

Another possibility is to invest the principal portion of the payments and take the interest income. In order for this to be effective, however, the interest gained needs to exceed the rate paid on the loan.

Interest only jumbo mortgages can also allow you to procure a larger loan, therefore able to buy more house. Again, this would be based on an expected rise in income somewhere along the line. The interest only mortgage offers the lower payments you require. So you can invest, as described above, and move towards your goal of home ownership.

What Hazards Should You Watch Out For?

There are deceptions about purported desirable features of interest only mortgages that don't actually exist.

• Deception 1: An interest only mortgage has a lower rate.
• Deception 2: An interest only mortgage does not require mortgage insurance.
• Deception 3: On ARMs with an interest only option, the rate quoted is fixed for the interest only term.
• Deception 4: Amortizing an interest-only loan is less costly.

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