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Interest Only Mortgages

May 27, 2008  |  Difficulty: Easy

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This type of mortgage is similar to credit. You pay only the interest on the mortgage. This will give you lower payments, especially in the time of a financial bind. But in the case of an interest-only mortgage, the debt is never really paid off.

Depending on your specific contract, you will pay only the interest for 5, 10 or 15 years. This means that the monthly payments are very low, and that is why this option has increased in popularity in recent years.

Interest only mortgages take the balloon mortgage approach. Basically this means that once the interest is paid off at the end of the term, the total amount of the actual loan is due.

Why is this so popular? Well, at the time when the price for housing has increased, consumers are looking for a way to drastically lower their monthly payments. With an interest-only mortgage the interest rate is average but the monthly payment is lower than the interest and the principal balance. A lower monthly payment means more pocket money to spend for other needs.

In some cases, the interest-only mortgage has an interest only period up to 5-15 years. After this period, you will begin to pay for the interest and the principal balance. If the term lasts for up to 30 years, there will be an initial interest-free term and then a borrower will need to pay both interest and the principal balance, so that the loan can be paid within the 30-year period. When calculated, your payments will be considerably high once the term is over, and will be higher than if you paid on the principal balance from the beginning.

Then, some interest-only mortgages are similar to balloon mortgages. Although with a balloon mortgage you are paying down the principal balance over time. So this means when you pay the final payment at the end of the term, the sum of that payment will be less than the original amount since you have been paying interest and principal all along. But when your term ends on an interest-only mortgage that works like a balloon mortgage, the ending payment will be the exact amount as the initial loan amount. Why? Well, because you paid only the interest and none of the principal balance.

This seems to be a gamble. So when is this type of mortgage right for you? If you are the sole breadwinner within the family, and if you are taking sole financial responsibility over the mortgage, this option is NOT for you. Investors may want to apply, though. Because the interest paid is tax deductible. While you own the property you can subtract the interest that you paid from your taxes. When the term ends you can then sell the property, that will hopefully bring you profit. Then you can take the money made to pay off the mortgage.

Still, investors beware. This is still a financial risk. There is no way to ensure that the property will increase in value. And, there is no way of telling if you will be able to sell the property when you want to. Refinancing may be an unwanted option if you cannot sell on time. If you have made enough money from the property to pay the ending, total balance of the mortgage, then there should be no troubles.

This type of loan is beneficial because the investor can save the money that would pay for the principal part of the loan. This extra money will be beneficial in some way or another.

Interest-only mortgages have similar options as the other loans. There can be a fixed rate for the entire term, or there can be an adjustable-rate set up. This will allow for a fixed rate for a certain amount of time, and then the rate will adjust every year after that initial time period.

The overall monthly savings for an interest only mortgage can be great. And your situation will be even better if your property increases in value.

If you live on an irregular income level because you are paid on commission and frequent bonuses, interest-only can work for you. You can have the option to pay interest during time of little income. But when the commission is high and the bonus is generous, you have the option of paying more than what is due monthly. Make sure there is no prepayment penalty on this type of loan. This works because your balance is low when you need it, but you can pay significantly more when the money train arrives.

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