Interest Only Mortgage

An interest only mortgage is exactly what it sounds like. With a traditional mortgage, a portion of your monthly payment is applied towards your principal while another portion goes towards interest. With an interest only mortgage, you do not pay down your principal at all for the first 5 to 10 years. In this way, you will have lower monthly payments during the interest only period but much, much higher payments if and when you begin paying down your principal. Most borrowers who take out an interest only mortgage never get to this point, however. Instead, they opt to refinance, sell their homes or pay down the balance in a lump sum after the interest only period ends.

To understand who might benefit from an interest only mortgage, it’s best to look at it in terms of trade-offs. On the one hand, you’ll pay much less month-to-month with an interest only mortgage. But on the other hand, you won’t be building any equity. With this arrangement, it falls upon the borrower to invest the money that he or she saved in the short term into a vehicle that outperforms an investment in their home equity. For executives, stock brokers and venture capitalists, this may not be much of a challenge. For investing, an interest only mortgage is highly advantageous. Not only are mortgages one of the more affordable sources of credit, mortgage interest is tax deductible. But for everyday wage earners, finding a stable investment that will realize a better return than the appreciation of their home by the time the interest only period ends may be difficult.

Given the riskiness of investing money elsewhere instead of paying down your mortgage and building home equity, interest only mortgages are best suited to affluent individuals or young professionals on the “fast track” to wealth. If you reach the end of the interest only period and do not have the cash to pay down the principal or can’t refinance, you could face losing your home.

Contrary to the allure of a lower monthly payment, interest only mortgages aren’t meant for those with little income or assets. However, interest only mortgages may be suitable for those with unpredictable incomes, such as executives who receive the bulk of their pay through bonuses or self-employed individuals who experience “feast or famine” income cycles.

In summary, interest only mortgages are designed for flexibility. They allow those with the means to manage their money effectively to place their money in an investment that outperforms their home equity. But if you’re not prepared by the time the interest only period ends, you could end up paying through the nose.