What are "interest only" mortgages?

By: Syd Johnson

Mortgages are considered to be “interest only" if your monthly payment does not cover the entire loan payment due, that is the mortgage interest and a payment to decrease the loan principal.

Every month you are paying the interest only and this means that the loan is literally not going away. The purpose of setting up an interest only loan is to give the customer the lowest possible monthly payment while still maintaining the loan.

Cannot afford the full monthly payment?
If you are in a position where you cannot afford the full monthly payment, a lender might allow you to pay the mortgage interest for the first couple of years and then the loan will be fully amortized at a future date. If you do get an interest only mortgage try to make the interest only period as short as possible.

Make a projection: can you pay two years into the loan?
If you cannot get out of the interest only cycle within a year or two then perhaps you are not in a financial situation where you can handle a mortgage.

Another option is to get smaller home loan so that you can afford the full loan payments as soon as you close escrow.

Many consumers will find that when they get preapproved for a home loan, the amount might be more than what they need, or more than they can realistically afford.

Full monthly payments will be higher than if you start paying on day one
Once the interest only period is up and your loan is fully amortized, be prepared for some sticker shock. On the average loan, sometimes one half or more of the monthly payment goes towards the mortgage interest, and only a fraction of the actual payment goes towards paying off the loan.

If you are making interest only payments during the first year make sure that you can afford the full payments within a year or two. If you are expecting a significant raise in your salary, an inheritance, or some other type of cash windfall, then this type of loan can be an option.

These loans are very rare
Interest only mortgages are very rare in today’s economy. They were heavily abused in the past by consumers who bought homes that they really could not afford and predatory lenders who brought customers into the home ownership market before they were fully prepared to handle the financial responsibility.

Best for professionals who expect a lot of cash very soon
Unless you are a young professional such as a medical student, law student or graduate student who can expect a significant raise in their salary when your schooling is complete, talk to your mortgage broker about any alternatives to this type of home loan.

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