One option for a mortgage loan with affordable monthly payments is an interest-only mortgage loan. While your monthly payments may be low with an interest-only mortgage loan, there are some drawbacks to this type of loan. These drawbacks often don’t show up until after you’ve had the mortgage for a few years.
What Is an Interest-Only Mortgage?
Usually, monthly mortgage payments are made up of part interest and part principle. Interest-only mortgages allow you to make interest-only payments on your mortgage for a certain number of years. Once the interest-only period has expired, your payments will include both the principle and interest on the loan.
Interest-only mortgage loans are usually also adjustable rate mortgages. That means the interest rate on the mortgage adjusts during the life of the loan. Interest rates on an adjustable rate mortgage can change anywhere from monthly to every five years depending on the terms of your mortgage. This means payments on your interest-only mortgage may vary during the part of your mortgage that has an adjustable rate.
Watchouts
Your payments will increase after the interest-only period has expired since principle payments are then required. When that happens, your payments could more than double, even if your interest rate stays the same. Your payments could increase beyond that if the interest rate goes up at the same time the interest-only option expires.
It’s common for interest-only mortgages to include a prepayment penalty that would cause you to owe an additional fee if you refinance your loan within the prepayment penalty period, which usually lasts the first three to five years of the mortgage. Some prepayment penalties are fixed fees, .e.g 2% of the mortgage. Others decline as your mortgage ages. Prepayment penalty could make it impossible to refinance your home when your interest-only period ends.
Is This a Good Idea?
An interest-rate only mortgage might good an idea for you if your income is low right now and you expect it to increase by the time the interest-only period expires. This increase in income would make it easier to afford your mortgage payments once the principle payment kick in. However, if you don’t foresee an increase in income, an interest-only mortgage is a bad idea, even though it may be the only mortgage you qualify for right now.
Even though you’re only required to make interest payments on your mortgage, you can make higher payments. This might be a good option if you have a variable income that’s high in some months, but low in others. But, you’ll only reduce your mortgage if you actually make payments toward the principle during the months when your income is higher. Remember that as long as you’re only paying interest on your mortgage, the balance won’t go down.
If you’re considering an interest-only mortgage, you should continue shopping as you would with any other mortgage. Consider the interest rate, payment adjustments, prepayment penalty, and other features of the loan before deciding it’s the right one for you. Remember, that an interest-only mortgage is a riskier type of loan based on the increasing interest rate and sign up with caution.
