Friday, September 08, 2006

Interest Only Mortgage

As the name implies, interest only mortgage is where you only pay the interest for a temporary time, which is usually 5 or 10 years. Homeowners may pay more than the minimum balance to lower the principal balance. Remember, principal is the amount of money you owe to the lender. Interest is what the lender charges you for the loan.

If homeowners only pay the interest, the balance of the loan remains unchanged. That's because none of your payment is going toward the principal. When the interest only term expires, your monthly payment will increase to include the principal. For example, for a $100,000 loan at 6.25%, the required monthly payment is $520.83 for the first 5 or 10 years. Without the interest only option, the required monthly payment will be $615.72.

Who buys interest-only mortgage? People who likes the flexibility of paying the principal. People who wants to buy a more expensive home. People who expect their income to rise over the next few years. People who need to invest the difference (Interest minus the principal) in hope that their investments' rate of return will be greater than the interest being charged on their mortgage. If you don't meet any of these reasons, this type of mortgage is definetly not for you.

Why am I against this type of mortgage? For one, you are not paying any principal into your home. Therefore, you are not building any equity into your home. Equity is included when determining the value of your home from year to year. In the long run, you may need to use the equity to fix up your home or for emergency uses. If you don't have any equity, you don't have this option. Second, when your interest-term expires, homeowners may experience a huge payment shock because their monthly payment just increased. Third, this is a high risk loan to the lender. Because of this high risk, the lender will charge more fees than a traditional loan that includes principal and interest in the payment.

To learn more about what the US Government has to say about Interest-only mortgage, go here: