Interest only mortgages are a type of Adjustable Rate Mortgage that features payments based on the amount of interest due for that month. Traditional mortgage loans come with payments amortized for full repayment over a certain period of time. During the interest-only period of this loan the payment is not amortized at all. Here are the basics of interest only mortgages to help you decide if this type of mortgage is right for you.
Interest Only Mortgage Payments
During the interest only period your payment amount is based solely on the finance charges due that month. Interest only periods vary and will be specified in your loan contract. This interest only period could last as long as five years. During this time you will not repay any of the principal loan balance; the loan balance will not go down at all during the interest only period. The advantage of interest only loans is the payments will be significantly lower than if you had a traditional mortgage that included loan principle.
Interest Only Loan Conversion
When the interest only period comes to an end, your mortgage lender will convert the loan to a traditional, adjustable rate mortgage. The payment for this loan will be fully amortized based on the remaining time in the loan’s term. If for example, your interest only period was 5 years on a 30 year mortgage, the payments would be based on a 25 year repayment schedule. This shorter amortization schedule means your payments will be significantly higher that they were during the interest only period.
Pros & Cons of Interest Only Mortgages
Interest only mortgages can be a beneficial tool for homeowners in certain financial circumstances. Interest only mortgages are ideal for borrowers that need short term financing such as real estate investors. The disadvantage is that you do not build equity in your home during the interest only period. This is a very expensive way of financing your home. Additionally, the mortgage payments will go up significantly at the end of the interest only period. If you are unprepared for this higher mortgage payment you risk losing your home to foreclosure. You can learn more about your mortgage options, including costly mistakes to avoid by registering for our free mortgage refinancing guidebook: “Five Things You Need to Know before Refinancing Your Mortgage.”