In the US, an interest-only mortgage means that the borrower only has to make payments on the interest of the loan for a certain period, rather than the full amount. After a specified time, the home loan reverts to the full amount and the borrower has to make payments on the entire loan including the interest.
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As with any type of lending, there are pros and cons. Here are some benefits and disadvantages of interest-only mortgages to help you make the right decision when buying your perfect home.
Advantage: Small Beginnings
As we’ve already mentioned, the small payments at the beginning of an interest-only mortgage can be a big advantage if they’re utilised correctly. As well as offering investment opportunities (despite their risk), this period also gives first time buyers a great chance to get settled and set up financially.
Interest-only mortgages are a great option for new couples or single home-owners to enter into the market while they seek out financial stability and establish good salaries. Usually, this period of lower repayments provides the freedom to work and earn enough to be able to afford the second period of the loan.
Disadvantage: The Big Finale
Having mentioned the advantage of the first period, the second period of the loan always lands itself in the opposing camp!
The second period is usually always longer than the first too, and so if you haven’t set up or planned your finances sufficiently, it could be a long uphill struggle for a couple of decades!
Although this could put you off getting a loan, remember that it’s usually only a big disadvantage in cases where lack of planning or unfortunate circumstances occur. Due to the remainder of the loan still being at the full amount, this second period means that much higher payments are required.
Although it’s always a risky business when dealing with investment, an interest-only mortgage gives you the chance to invest the repayment money that you would have had to pay straight away without going interest-only. If your investment is a success, it can help you pay off the loan and interest in the second period of the mortgage scheme. This advantage is definitely a risk, but if it works, it’s worth it. There needs to be a high level of financial know-how and experience involved because if it fails, you could be in trouble!
Investing in properties most often requires a mortgage
Disadvantage: Changing Rates & Switching
During the first period of the home loan, interest is normally charged at a fixed rate. When this period finishes, the rates become adjustable, meaning that there could be a disadvantage for the borrower. Obviously, if the interest rates go down then its great news, but if they have increased you wind up paying more than you budgeted for.
A wise move to avoid this disadvantage is to avoid interest-only loans when interest rates are low. Although this may seem backwards, it’s a long term advantage since they are likely to get higher over your mortgage repayment duration.
Advantage: Highly Qualified
Always end on a high! Our final advantage is a great reason to take out an interest-only mortgage, especially those who need to make their budget stretch that little bit further.
Your mortgage application is based on your income and your debt. Therefore the maximum monthly loan payment you can afford therefore dictates the maximum loan that you can take out for a mortgage. The smaller the first period of loan payments are in the interest-only mortgage, the higher total loan you can qualify for. This means that the interest-only option gives you a chance to take out a much higher loan than you would qualify for with other options. You might just be able to afford your dream house after all!
The all too familiar mortgage application form
As far as mortgages are concerned, there is always a repayment plan the best suits your individual needs and circumstances. The great thing about having different options is that you’re bound to find one right for you.
Interest-only mortgages do have some downsides in the latter half of the repayment term, but they also provide fantastic options for investment and financial freedom in the first part of the loan.
Remember that with every loan, you can make it work to your benefit if you put in plenty of planning and keep on top of your finance. Go for an interest-only mortgage, and you could be sitting in your new home sooner than you think!