By: Louie Latour
Interest only mortgages can be a great way to secure short-term financing to purchase your dream home. Interest only mortgages are risky; you should know what you are getting into prior to taking out an interest only mortgage. Here are the basics of interest only mortgages.
Traditional mortgages are fully amortized loans; this means you have a fixed payment schedule to pay off the mortgage at the end of the loan term. Interest only mortgages do not have fully amortized payments during the interest only period. At the end of the interest only period the loan will be converted to a traditional amortized loan with a variable interest rate.
The Interest Only Period
Interest only mortgages are not interest only forever; the duration of the interest only period will be specified in your loan contract. During the interest only period the mortgage payment is based on the interest due that month alone. This means none of the loan’s principle balance is being repaid. The advantage of this loan is the monthly payment is significantly lower than it would be with a traditional loan.
Mortgage Conversion
At the end of the interest only period the lender will convert the loan to a traditional mortgage loan. The monthly payment will change to a fully amortized payment for the duration of the loan. The bad news is you will be required to pay the full amount of loan principle in less time than with a traditional mortgage. This will result in a significantly higher mortgage payment.
Pros and Cons of Interest Only Mortgages
Interest only mortgages are an excellent short-term fix for homeowners that cannot afford fully amortized payments for a short period of time. The downside is that these interest only payments do not build equity. If you are unable to afford the payments when the lender converts the mortgage, you risk losing your home. To learn more about your mortgage options, including how to avoid common mistakes, register for a free mortgage guidebook.
