An interest-only mortgage is a type of mortgage in which the mortgagor (borrower) only has to pay interest on the loan for a certain period. The principal can be repaid in one lump sum on a specified date or in subsequent payments.
- An interest-only mortgage is one where you pay interest only for the first few years of the loan, not your payments, including principal and interest.
- Interest-only payments can be made for a specified period, as an option, or over the life of the loan (requiring you to pay it off in full at the end of the loan).
- Typically, interest-only loans are offered as a special type of adjustable-rate mortgage.
- While an interest-only mortgage means fewer repayments over some time, it also means you haven’t built up an asset, and it means your repayments have increased significantly at the end of the interest-only period.
Understanding Interest Mortgage
Interest-only mortgages can be structured in various ways. Interest-only payments can be made within a specified period, as an option, or over the life of the loan. For some lenders, paying only interest may be a rule that only applies to certain borrowers.
Most interest-only mortgages only require interest payments for a specific period (usually 5, 7, or 10 years). After that, the loan will be converted to a standard Schedule A fully amortized on this basis, the lender’s jargon and The borrower’s payment will increase, including both interest and a portion of the principal.
Typically, interest-only loans are offered as a special type of Adjustable Rate Mortgage (ARM) called; Interest Only. You only pay interest, at a fixed rate, over a certain number of years, called an introductory period. After the introductory period ends, and the borrower begins to repay the principal and interest, the interest rate will begin to change. For example, if you take out a “7/1 arm,” which means your introductory interest payments only last seven years, then your interest rate will be adjusted once a year.
Fixed-rate only mortgages are uncommon; they typically exist on longer 30-year mortgages.
Pay off interest mortgage
At the end of the interest-only mortgage term, borrowers have several options. Some borrowers may choose to refinance after the interest-only term expires, which can provide a new term and potentially lower interest payments on the principal. Other borrowers may choose to sell their mortgaged home to pay off the loan. Still, other borrowers may choose to pay off the loan in one lump sum when it comes due because they haven’t paid the main loan for so many years.
Special Considerations for Interest-Only Mortgages
Some interest-only mortgages may include special terms that allow interest-only payments under certain circumstances. For example, if there is damage to the home, the borrower may only be able to pay the interest portion of the loan, and they will have to pay high repair costs. In some cases, borrowers may only have to pay interest for the entire term of the loan, requiring them to manage their lump sum payments accordingly.
Pros and cons of interest-only mortgages
Interest-only mortgages reduce the monthly payments a mortgage borrower requires by excluding the principal portion from payments. The advantage for home buyers is increased cash flow and greater support for managing monthly expenses. For first-time homebuyers, an interest-only mortgage also allows them to defer big repayments into future years as they anticipate higher incomes.
However, just paying interest also means that the homeowner doesn’t build any equity in the property, which can only be done by paying back the principal. Also, when the payouts start including the principal, they get significantly higher. This can be a problem if it is related to a person’s economic downturn, job loss, unexpected medical emergency, etc.
Borrowers should be cautious about estimating their expected future cash flows to ensure they can meet their larger monthly obligations and make loan repayments when needed. While interest-only mortgages can be convenient for several reasons, they may also increase default risk.