What Is An Interest Only Mortgage?

For a long, long time, the mortgage industry was a conservative, stable industry with two or three loan options. Then everything changed. Interest only mortgage loans were one such change.

What Is An Interest Only Mortgage?

What is an interest only mortgage? In simple terms, it is a home loan wherein you only pay the interest accruing on the mortgage for a set period of time. If you borrow $300,000 from a bank to by a home at an interest rate of six percent interest, your monthly mortgage payment will be equal to that six percent interest. It will not include any principal on the loan. At the end of the loan repayment period, you will still owe $300,000.

Given the fact you are not paying off any of the principal, why would someone choose an interest only mortgage? The answer can be found in two terms - monthly payments and appreciation. Here is a closer look.

When calculating what you can afford in relation to a mortgage, one of the primary elements is the amount of the monthly payment you are committing to. Your monthly payment is made up a variety of costs that are highly dependent on the particular loan you choose. These costs can include the interest being charged on the loan, private mortgage insurance if you put less than 20 percent down, property taxes, homeowner's insurance and repayment of the principal of the loan. If you can eliminate one or more of these elements, the amount of your monthly payment goes down. With an interest only loan, you are obviously eliminating the principal part of the equation, which can drastically reduce the monthly payment.

The second part of the equation is appreciation. Since you are not paying down the principal on the loan, you need to look for another way to build equity. When you choose an interest only loan, you are betting that the property will appreciate during the term of the loan. Appreciation is simply the rate at which a property increases in value each year regardless of mortgage issues. During the recent blazing hot real estate boom, appreciation rates of 20 percent were not unheard of in many parts of the country. This, of course, made interest only loans very attractive.

As the real estate market cools off, the danger of interest only loans is becoming apparent. If a home does not appreciation in value or drops in value, you get upside down. Upside down simply means you owe more money on the loan than the property is worth. If you get into such a situation, you are in trouble because you cannot refinance the interest only loan since no bank is going to give you more money than the property is worth.

If you are interested in applying for an interest only loan or finding out more information, you should speak with a reputable mortgage profession. You can get a free, no obligation consultation by clicking here.

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