Interest only loans were once a loan product for more affluent buyers. Now interest only loans attract more people because they allow buyers, as well as investors to purchase more expensive homes.
After the completion of the fixed period of time, the unpaid balance is fully amortized over the rest of the period by paying the interest and the principal. You can refinance, pay the balance in a lump sum, or begin paying off the principal. Whatever way you choose, your payment will increase.
Benefits of Interest-Only Mortgage Loan:
- An interest-only mortgage allows the borrower to pay the lowest possible monthly payment for a fixed term.
- Short-term borrowers who are not as interested in building equity but would prefer to have lower payments.
- Business owners with less stable incomes would benefit from interest-only mortgage loans when some months may be lean on income. Additionally, those months when you have greater cash flow, you can pay on the principal, if desired.
- Executives who earn a modest salary during the year but whose primary income comes from bonuses would benefit from an interest only loan.
- If you are a young professional just starting out and expect to earn a higher income in a few years this may be a good option for you.
- Borrowers who believe it would be more beneficial to invest their income in the stock market and its returns and not property.
- Investors who believe the property will appreciate would benefit from an interest-only loan as their fixed term monthly payments will be lower as the property grows in value.
Risks of Interest-Only Mortgage Loans:
- The borrower will not have sufficient income to satisfy the principal and interest once the interest-only period ends.
- Nothing is paid toward the principal during the interest-only period and you experience payment shock.
- Payment shock occurs because the overall term of the loan is (30) years and for a fixed period mortgage, for instance (5) years, you were only paying the interest on the loan. Now, in order for the lender to amortize your loan and ensure it is repaid in the remaining period (25) years, your payments are recalculated on a (25) year repayment schedule using your current balance. Your payment is going to increase tremendously.
- Interest rates rise but your home goes down in value, making it impossible to refinance.