The Pros and Cons of an Interest Only Mortgage

by Karen Lawson
Loan Page Columnist

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As home prices soar, you may wonder if you will ever be able to afford a home loan. An interest only mortgage may be an option. But before choosing an interest only mortgage, it's important to understand how it works, how it can affect your home equity, and the risks involved.

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New Mortgage Products Offer Lower Payments

Mortgage lenders offer a variety of loans to meet individual circumstances. With interest only loans, you repay interest only during an initial period--that means you your payments are much lower during this period than they would be with a regular mortgage loan; however, when the initial period is over, your payments will increase substantially.

There are several reasons to consider an interest only mortgage:

» Buying Power: Lower initial payments can help you qualify for a larger loan
» Cash Flow: These loans offer more flexibility for business owners and others with irregular cash flow
» Lower Initial Payments: provide flexibility for investing or saving

Interest Only Mortgages and "Guesstimating" Future Assets

If you're on a tight budget, an interest only mortgage may not be right for you, unless you anticipate a substantial increase in income and your home's value. An example of this would be medical students buying a home. They can reasonably expect to earn more once they complete their training and begin to practice. An interest only mortgage may not be your best choice if you don't anticipate increased income and property value.

Some things to consider when examining interest only loans include:

» If you're paying interest only, and property values decline, you could actually lose equity in your home
» If you pay interest only, you will not accumulate equity (unless the home's value increases independently), which can be used as a source of funds for future needs
» The benefits of this loan type depend on variables such as how much you save, and projected increases in your income and your home's value--such forecasts can be risky, as there are no guarantees

If you need to maximize cash flow, and can reasonably project increases in income and your home's value, an interest only mortgage can be a useful financial tool. But before getting this type of loan, be sure to realistically assess your situation to ensure you can make your payments now and when the initial interest only period ends.

About the Author
Karen Lawson is a freelance writer with more than fifteen years of experience in mortgage lending. She earned an MA degree in English from the University of Nevada, Reno.

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