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When Does the Interest Only Mortgage Make Sense?

by Gabriel  Traverso
Mortgage Directory Columnist

Today there are a number of alternative mortgage options available to consumers, but few home loans are "one size fits all." For those wanting to buy more home, the interest only loan might seem like an attractive solution. However, it could spell disaster for some.

The interest only mortgage combines an alternative payment method with a more traditional home loan. Initially the loan has a set period during which you only pay interest on the loan -- and typically at a lower rate than standard fixed-rate mortgages. Then the loan moves to a fully amortized schedule at an adjustable rate.

For a savvy investor it might make sense to only pay the interest on the property and reserve the principal portion of the mortgage payment for more profitable investments. For the average homeowner it doesn't make much sense at all. Originally intended to help borrowers leverage their cash flow, interest only home loans are now being marketed as a way to buy more home than you can really afford.

More Loan Now, More Debt Later

Let's say you're pre-qualified for a $200,000 home loan with a rate of 6%. Your monthly mortgage payment would be $1199.10 of which about $1000 is interest. In an interest only mortgage the same monthly payment could mean you could borrow an additional $40,000 towards your dream home. Sounds good, doesn't it? However, at the end of the interest only period when your payments skyrocket not only will you have little to no equity in your home, the interest only mortgage will cost you thousands of dollars more over the life of the loan.

The bottom line is this: the interest only mortgage is the perfect solution for very few borrowers. Those not planning on staying in their home more than five years, or with another investment vehicle for their funds, can make these home loans work. For most of us, the traditional 30-year fixed-rate mortgage is still the best option around.

HSH Associates

About the Author
Gabriel Traverso is a freelance writer, independent musician, and artist. He resides in Reno, NV.

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