If you’re thinking of buying a home then you have likely been considering your mortgage options. Shopping around for the best rate is common among people who are looking for a mortgage but many overlook the interest only mortgage option.
This type of mortgage is not the most common way to purchase a home and it certainly has some benefits as well as some drawbacks. Because of the mystery that can surround these mortgages, many people simply opt for a traditional mortgage instead of learning more about interest only mortgages.
While these mortgages definitely aren’t for everyone; having the information available to make an educated decision is always a great idea. Ready to learn more about this mortgage, what the pros and cons are, and who could make use of this different type of financing? Let’s jump into it!
What Is An Interest Only Mortgage?
As the name suggests, an interest only mortgage is a mortgage where borrowers are only obligated to pay the interest rather than the principal plus the accrued interest.
As you may imagine, this can drastically reduce the amount of money required for each payment. Those low payments can seem attractive to some buyers but there is always more to things than just the monthly payment.
Typically, an interest only mortgage is structured for interest only payments near the beginning of the mortgage with regular payments commencing during later terms. Of course, each lender will have its own unique structures and policies.
Now that you know what an interest only mortgage is; is having one a good idea?
The Pros Of Choosing An Interest Only Mortgage
We already gave away the biggest benefit of choosing an interest only mortgage in the section above: lower payments!
By opting for an interest only mortgage, borrowers can lower their payments substantially which is great for new homeowners with big dreams. The reduced payments allow for additional cash flow in the household budget that can be used for a variety of purposes.
For those who have never owned a home, some of the surprise costs that come after buying a home can be shocking. Property taxes, repairs, maintenance, and landscaping are all things that may need to be taken care of immediately. Lower monthly mortgage payments makes coming up with the cash for these projects much easier.
The lower payments of this mortgage also allow homeowners to get used to the concept of paying a mortgage alongside the other costs that come with homeownership. Renters, for example, don’t have to concern themselves with HOA fees or property taxes as those costs are baked into the cost of their rent. Homeowners do not have that same luxury. The cost of a mortgage is just one cost associated with owning a home. By opting for an interest only mortgage, there is more wiggle room to learn and adapt to the true costs of owning your own home.
Finally, one of the other reasons many people opt for an interest only mortgage is the flexibility. The minimum payments for these mortgages are interest only but there is often no rule against paying down a portion of the principal balance as well.
Homeowners can pay interest when money is tight and then pay more when there is more cash on hand. This flexibility can be incredibly valuable for people who want to explore the world, for example. Paying interest only while traveling is much more manageable than paying a full mortgage payment.
The Cons Of Choosing An Interest Mortgage
It’s not all rainbows and positivity for those who opt for this mortgages. There are some very serious risks to consider when choosing one of these loans.
The most obvious downside is that you cannot build equity in your home by only paying interest. This is, obviously, ignoring appreciation in real estate value. Even some of the hottest markets in the country would only allow for marginal equity gains as you only pay down interest.
The problem with not building equity is that a home loan could very easily end up underwater. Finding out your home’s value is underwater can be stressful and demoralizing. Not to mention, with the right situation, it could be financially devastating and result in the unwanted sale of a home in order to cover a loan.
Interest rates on interest only mortgages also tend to be higher than traditional mortgages. This means that, over time, you may actually end up paying more in interest for the home than if you had just chosen a traditional mortgage. Yes, the payments may be lower to begin with but the costs will be realized at some point during the loan.
There is always risk in taking out a loan and interest only mortgages are no different. However, they do add the additional risks that you simply will not see in traditional mortgages.
Who Should Choose This Type Of Mortgage?
Now that you know the pros and cons of an interest only mortgage it is time to consider some scenarios where this type of mortgage may make sense when compared with a traditional mortgage.
Interest only mortgages are commonly taken on by new homeowners. These people have never owned a home and have no idea what to expect when it comes to the costs of homeownership. The down payment to secure the loan and the monthly payments are just part of the story.
By opting for an interest only mortgage, new homeowners can slowly get a feel for homeownership. The first few years will be interest only to allow for smaller payments. Homeowners can become accustom to paying regular payments as well as managing other expenses before truly taking on the full cost of their mortgage payments.
Buyers who earn an inconsistent wage are also great candidates for an this mortgage. This category would include, for example, people who work on a commission basis that may see monthly fluctuations in their pay.
For these people, this mortgage allows for flexibility that accommodates their pay. Minimum, interest only payments can be applied regularly and, in busy months, borrowers can choose to apply their surplus earnings against their loan to reduce the principal balance owing.
Finally, those with significant funds for a down payment may be interested in interest only mortgages. By putting down more money up front they have reduced the chance they may find their home loan is underwater. These buyers can enjoy the flexibility of this mortgage without having to worry that they have not built any equity in their home.
Of course, your unique situation may differ from these examples. Truthfully, this mortgage can work for anyone assuming you have the right mindset before you sign on the dotted line.
What To Consider Before Signing An Interest Mortgage
Still on the fence about whether an interest only mortgage is right for you? Here are some things to consider before you put pen to paper.
First, do you have the commitment to pay down the principal at all? While an interest only mortgage does not require principal payments it is a good idea to slowly chip away at the balance owing on your mortgage. Even if only 1 of 3 payments include any extra funds to go toward the principal balance that is still a better strategy than simply paying interest only.
Next, consider the funds you have on hand. Do you have enough for a significant down payment? Can you manage any unexpected expenses after moving into your new home?
If you are able to put down a significant portion of the cost of the home then this mortgage may be a good way to ensure your cash flow availability remains high after buying. On the other hand, having savings available after moving in will reduce the need for lower payments to fund repairs and maintenance.
As you can see, choosing this mortgage is largely a personal decision. If you have a good understanding of your options and the benefits of all options, then you will be able to make a better decision for your unique situation.