An interest only mortgage is not widely available and it’s something that not all clients prefer. It has its own pros and cons. If you’re planning to apply for a mortgage and purchase your dream house, it’s important that you have a better understanding about this type of mortgage so you know your options. This would help you in making the best decision on which would suit your needs.
The Basics of Interest Only Mortgage
Traditional mortgage may have fixed or variable rate, but the principal and interest is paid monthly for the duration of the loan. In the fixed rate mortgage, the interest rate remains the same for the rest of the loan. The good thing about this is that you know specifically how much you would pay per month so you could work on your budget properly. With a variable rate, the interest that you would pay would depend on the market rate for every month that you would be paying. If it gets down, then the amount that you’ll pay would go down. However, if it goes up, then the amount that you’ll pay would also increase. Regardless, as mentioned, you would still be paying for the principal amount.
With an interest only mortgage, you would only be paying for the interest rate for the first years of the loan. After that, you would be paying for the principal amount and the interest rate, which is usually adjustable. The number of years that you would only be paying for the interest would depend on the lender, but it’s typically from 5 to 10 years. You would pay for the fixed interest rate during these years. After this, the interest rate would increase depending on the benchmark interest rate for that year and the interest cap. The interest increase is usually limited to up to 2% per year only.
To make interest only mortgage easier to understand, let’s make a sample computation of how much you would be paying if you apply for this type of loan. If you took a $100,000 interest only mortgage for 30 years with 10-year interest only payment; you would only pay for the monthly interest for the first 10 years. Say in the first 10 years, you would only be paying $292 per month for the interest. However, this interest rate could double for the remaining years of loan payment because of the yearly increase of the interest rate. Aside from the higher interest rate, you would also start paying for the principal loan, which installment amount would also be bigger because instead of having 30 years to pay for it, you would only have 20 years remaining.
Its Pros and Cons
Interest only mortgage has its pros and cons. The most obvious advantage is that the first few years of paying for the loan wouldn’t be too hard on the pocket since you would only be paying for the interest. Those who are just starting to earn may see this is an advantage. However, the drawback is that after the interest only payment, the monthly payment would blow up because of the increasing interest rate and the payment of the principal loan.
If you decide to apply for an interest only mortgage, make sure that you become financially ready to pay for the monthly payment after the first years of paying only the interest is over.
Featured and 1st image by Brett VA [CC BY 2.0 (http://creativecommons.org/licenses/by/2.0)], via Wikimedia Commons
2nd image courtesy of ddpavumba / freedigitalphotos.net