Interest Only Mortgages

By Susan M. Keenan

Interest Only Mortgages are frequently recommended for individuals who have a fluctuating income due to sales commissions, bonuses, or self-employment.  Additionally, they are recommended to individuals who are expecting to come into a sizeable inheritance in the future.

The basic premise of an interest only mortgage is to provide an individual with a smaller monthly mortgage payment in the early years of the mortgage when his or her income is expected to be at its lowest point.  Specifically, an interest only mortgage is one in which the borrower’s initial payments include only the interest on the loan.  After a predetermined term, the payments are recalculated and include the principal as well as the interest.  The size of the payment is now much larger since it includes both the interest and the principal.

What are the benefits to this type of mortgage?  An interest only mortgage allows borrowers to purchase homes with larger price tags than their current level of income would allow with a traditional mortgage.  The monthly payments in the early years of an interest only mortgage are considerably smaller than they would be with a traditional loan.

Additionally, an interest only mortgage can free up cash that would normally go to the monthly mortgage payments.  Therefore, new homeowners find that they can still afford the new cars, boats, expensive furniture, or frequent vacations that they also want.  A mortgage of this type may also allow individuals with other areas of debt such as student loans, car loans, credit card accounts, and installment loans to continue to pay off their debt while buying a home.

Unfortunately, some disadvantages exist with this type of mortgage as well.  The most glaringly obvious disadvantage to this type of mortgage, an interest only mortgage, is the plain and simple fact that the homeowner will not build up any equity in the home during the part of the mortgage term that is interest only. 

If hard times strike, and the homeowner is forced to sell the property, he or she will realize very little income from the sale due to the fact that no principal payments have been made.  Additionally, when the time arrives for the payments to include the principal as well as the interest on the loan, the size of the monthly payment will increase considerably.  This can create a difficult financial situation for the homeowner unless his or her income has gone up during this time.

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