What are "Interest Only" Mortgage Loans, and How Do They Work?

Are you thinking about buying a home but not sure what you can afford? Have you wondered about interest-only mortgages and what advantages and disadvantages they may offer? If so, then you’re in luck because we’ve collected some great information about interest-only mortgages!

What is an interest only mortgage loan? How does one work?

Interest only mortgages are mortgage loans where, for a certain number of months or years (the specific amount of time will be determined by the terms of your mortgage loan), your monthly mortgage payment only includes the interest due on your loan. During the interest-only period, you will not be paying down the principal of your loan – that will come after the expiration of the initial interest-only period. At the front end of your mortgage loan, your payments are likely to be significantly lower than they would be with a conventional mortgage loan set to pay the same amount over 15 or 30 years. Interest only loans are offered on both fixed rate and adjustable rate mortgages.

An interest only mortgage loan could help you close on the home you want instead of settling for the home you can afford today, as your lender will look at your debt to income ratio based on the lower interest-only payment amount rather than the higher payments that will come at the end of the interest-only period.

What are some advantages and disadvantages of interest only mortgages?

One of the main advantages of an interest-only mortgage loan is the amount of money you’ll save each month – wisely invested, that may reap you more financial benefits than paying towards principal right off the bat, especially if you live in a hot housing market where housing values are rising.

One of the main disadvantages of interest only mortgage loans is that for many people the amount of the monthly mortgage payment following the expiration of the interest-only period will be higher than it may have been if you had been paying towards the principal since the beginning of the loan. You can turn this disadvantage into an advantage though: many people refinance their mortgage before the interest-only term expires, resulting in a more comfortable monthly mortgage payment.

Mortgages with interest-only periods are likely to save you money in the short-run but you may find that they may cost more over the 30-year term of the loan than a conventional loan. However, if you are able to invest wisely during the interest-only period or to refinance your mortgage during the term of your loan, an interest-only mortgage loan may make good financial sense for you and your family.

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