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Interest Only Mortgages – How It Works For You
Home buyers have a way to buy houses that they cannot normally afford. They can do this with interest only mortgages.
These types of home loans are gaining popularity because it allows for reduced monthly payments for the borrower.
For traditional loans, the monthly payment you make consist of a portion used to pay off interest and a portion that go toward paying the principal. As you make more monthly payments, the interest portion decreases and the principal portion increases until you fully pay off the mortgage.
An interest only mortgage allows you to only make interest payments in the initial years.
You will only start to pay the principal at a future specified period. This make your monthly payments lower and therefore, you can obtain a higher deal from the loan lender.
When you make a payment, the payment is typically used to pay off interest, taxes and insurance among others.
When the interest-only period is over, your monthly payments will increase as it now starts to incorporate your principal amount also.
These types of loans were extremely popular among investors who fully expect property prices to rise fast over a short period of time. The low initial payments allow them to retain control over the property until prices rise enough to recoup their investment costs plus their targeted amount of profits.
But it is an extremely risky way to approach investing. If the market goes down instead of up, these type of investors will be the hardest hit.
The core of the danger to these types of mortgage is that borrowers borrow based on the monthly payment amount. The lesser the installment is, the more attractive it looks to them.
Even new home buyers could be tempted to take on such loan structures. They usually do so with an expectation to refinance it in the near future.
But again, if property valuations fall, these owners will find it difficult to obtain refinancing as their homes are now worth as much as the mortgage or even less.
There is a variety of interest-only loans offered by lenders. They can come with adjustable rate and fixed rate options.
Paying Off Your Loan Faster With Interest Only Mortgages
By paying off your outstanding amount in lump sums, you can actually pay off your loan much faster than traditionally expected.
The main concern most people have with these forms of loans is that they may be subject to higher interest rates after the interest-only period. This really depends on the market. In all likelihood, there will also be a cap on interest rates that will be charged.
If you foresee that you will be making much more income in the future, this can suit you. When the interest-only period expires and you have to make higher monthly payments, your income can afford to take up the extra commitment.
Also note that you could have refinanced the home with a better deal even before the interest-only period expires.
For a start up businessman, such an arrangement can be very attractive. It allows him to buy a more luxurious home now.
These are very attractive to home buyers for a very simple reason. By not being required to pay off the principal during the initial years, the home buyer can use the funds originally set aside for the home purchase to invest in other investment vehicles.
It is very attractive for those who appreciates the time value of money and wish to use financial leverage to increase their assets.