The Pros and Cons of an Interest-Only Mortgage

For buyers who want a home right now, or who are purchasing a home knowing that it will be sold again in a short period of time, an interest-only mortgage can be a smart borrowing option. Unfortunately, many consumers aren’t familiar with these unique mortgage types, and aren’t aware of the pros and cons of getting involved with one.

What Is an Interest-Only Mortgage?

An interest-only mortgage is a loan in which the person borrowing funds pays only the mortgage’s interest for a fixed term (typically 5-7 years). At the end of the term, the borrower has the decision to either refinance the home, start paying down the loan principal, or make a large payment.

What Are the Pros & Cons of an Interest-Only Loan?

There are many pros of an interest-only loan, the main of which are as follows:

• These loans make it easy to facilitate low payments during the set term
• People who take out interest-only loans can spend the term putting more money into various investments, which helps them build up net worth
• Borrowers can qualify for a larger loan later, which allows them to purchase a larger home
• As long as a borrower’s payments are interest-only, they’re fully tax deductible

The cons of an interest-only loan are as follows:

• Instead of investing the money they’re saving on loan payments for the term, many people simply spend it, which places them in a tough financial position later
• Homes under interest-only mortgages may not appreciate very quickly, which may be opposite of what the borrower expected
• Principal payments are often much higher than interest-only payments, and many consumers can’t afford them
• In the event that income did not grow during the interest-only period, the borrower may find that the loan is more than he or she can afford

Who Should Apply for Interest-Only Loans?

Interest-only loans are ideal for some types of consumers and disastrous for others. As a general rule, experts recommend that only buyers who fall into the following categories apply for interest-only loans:

• Borrowers who are certain they can accommodate a larger payment down the road
• Buyers who plan to purchase the home and sell it again quickly
• Buyers who plan to invest the money they will save on their payments somewhere else, whit a much larger rate of return
• Borrowers who want to purchase more home than they can afford right now, but who have a large spike in income coming down the road

Interest-Only Mortgages: A Helpful Tool

While they’re not right for everyone, interest-only mortgages can be a smart decision for some consumers. As long as you’re confident in your ability to handle a large impending payment, these unique mortgage formats can be a great way to save money and live better right now.