The Pros and Cons of Interest Only Loans
Interest Only Loan – a mortgage that requires you to pay only interest for the first few years, allowing you to keep your monthly payments low.
Sounds great, right? Well, before you consider obtaining an interest only mortgage, you should explore the pros and cons associated with this type of loan.
How does an interest only loan differ from a traditional mortgage?
When you take out a traditional mortgage, your monthly payments are a mix of principal and interest. The principal portion goes toward repaying the money you borrowed, while the interest is what the financial institution charges you for the use of their money.
With an interest only loan, on the other hand, you pay only the interest each month, for a certain period of time – usually the first 5-10 years. Then, you have the remainder of your mortgage loan term to repay all the principal, plus interest.
So what are the pros and cons of obtaining an interest only mortgage?
PROS:
- More affordable during the first few years than a conventional mortgage, because you’re only paying interest.
- May allow you to buy a higher-priced home than you could otherwise afford, or to stay in a house you are having a hard time carrying with a conventional mortgage.
- Allows you to spend the money you save in the first few years on other priorities.
- Can be a way of investing in a rising real estate market.
CONS:
- Leaves you no better off, as far as equity growth in your home, when the interest-only period ends than if you had rented during that time period, unless the value of your home significantly increases.
- Eventually requires you to repay the entire outstanding principal in a shorter period of time, resulting in higher monthly payments.
- You could go “upside-down” on your mortgage loan – meaning you could owe more on your home than it’s worth – if the house declines in value during the interest-only period of your loan.
An interest only loan could be ideal for many reasons, and is a viable option for many people. However, you should approach this type of loan with caution. Ask yourself what your priorities are in purchasing the new home. If you plan to remain in the house for a long period of time, an interest only loan is probably not the best choice. However, if you expect an increase in your income, or would like to free up some of your cash right now for other investments, an interest only loan might be for you.
Just keep in mind, when the interest only period is over, your monthly payments will increase, so plan ahead.
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