Interest-Only Mortgage

by David Pham

Within the past several years we have witnessed an unprecedented surge in home prices in the USA, and as prices go up, it becomes increasingly difficult to finance real estate purchases. When you apply for a loan, the mortgage lender wants to ensure that you can make your monthly payments, so they compare your average monthly income to the amount of your payment. If the mortgage payment is too high, you will probably get turned down for the loan, even if you have excellent credit.

Lenders recognize this problem, and in order to make it easier to qualify for a mortgage, they sometimes offer what is known as an interest-only mortgage. The way it works is that your monthly payment includes only the interest you owe, without any additional principal payment. With an interest-only mortgage you can qualify for a bigger mortgage, and afford to buy a more expensive house.

For example, if you borrow $200,000 with a typical payment schedule, you will pay about $1,200 per month on a 6 percent loan. With an interest-only mortgage, your monthly payment will be just a thousand dollars saving you about two hundred dollars a month.

Something to consider...

The downside is that because you are not chipping away at the principal balance of the mortgage, eventually you have to pay it off and it will cost you more, in the future. Under the interest-only mortgage, you have the option of paying interest only for the first 10 years of the loan term. The mortgage is then fully amortized over the remaining term of the 30-year loan. Your monthly payments suddenly go up enough to make up for all those months when you didn’t pay any principal. In a worst-case scenario, you could avoid paying any principal for 10 years, and then wind up making higher payments owing the entire amount of your mortgage, after making monthly interest-only payments for the first ten years of the mortgage.

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