Interest Only Mortgage Loans - Benefits and Disadvantages

Interest-Only Mortgage Loans
by Lisa Phillilps
May 2007

An interest-only mortgage loan allows you to pay only the interest on
the mortgage that is stated in the note for a fixed period of time.That
fixed period of time can be 3, 5, 7 or even 10 years.

After the completion of the fixed period of time, the unpaid balance is
fully amortized over the rest of the period by paying the interest and
the principal. You can refinance, pay the balance in a lump sum, or
begin paying off the principal. Whatever way you choose, your
payment will increase.

Interest only loans were once a loan product for more affluent buyers.
Now interest only loans attract more people because they allow
buyers, as well as investors to purchase more expensive homes.

Benefits of Interest-Only Mortgage Loan:

An interest-only mortgage allows the borrower to pay the lowest
possible monthly payment for a fixed term.

Short-term borrowers who are not as interested in building
equity but would prefer to have lower payments.

Business owners with less stable incomes would benefit from
interest-only mortgage loans when some months may be lean on
income. Additionally, those months when you have greater cash
flow, you can pay on the principal, if desired.

Executives who earn a modest salary during the year but whose
primary income comes from bonuses would benefit from an
interest only loan.

If you are a young professional just starting out and expect to
earn a higher income in a few years this may be a good option
for you.

Borrowers who believe it would be more beneficial to invest their
income in the stock market and its returns and not property.

Investors who believe the property will appreciate would benefit
from an interest-only loan as their fixed term monthly payments
will be lower as the property grows in value.

Risks of Interest-Only Mortgage Loans:

The borrower will not have sufficient income to satisfy the
principal and interest once the interest-only period ends.

Nothing is paid toward the principal during the interest-only
period and you experience payment shock.

Payment shock occurs because the overall term of the loan is
(30) years and for a fixed period mortgage, for instance (5)
years, you were only paying the interest on the loan. Now, in
order for the lender to amortize your loan and ensure it is repaid
in the remaining period (25) years, your payments are
recalculated on a (25) year repayment schedule using your
current balance. Your payment is going to increase
tremendously.

Interest rates rise but your home goes down in value, making it
impossible to refinance.

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