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5 Interest-Only Mortgage Considerations

By Gretchen Wegrich Updated on 7/24/2017

interest only loanIs an interest-only mortgage right for you? With an interest-only mortgage, borrowers have the option of paying each month only the amount of the interest that has accrued. 

Since borrowers aren't required to pay anything towards the capital, less of each month's salary goes towards the mortgage payment.
If you're thinking about taking on an interest-only mortgage, here are five things to consider.

1. What are interest-only mortgage benefits?

An interest-only mortgage frees up money because each month, you're only required to pay accrued interest on the amount of capital owed. 

That leaves you with more money to invest or spend elsewhere. The interest amount depends on whether the interest-only mortgage has a fixed or adjustable rate. 

If it's adjustable, the amount also depends on the current base rate or the standard variable rate set by your bank. Sometimes the interest amount can even be zero!

Interest-only loans allow borrowers to only pay the interest on their loan for the first ten years. For example, a 30-year $1 million mortgage with a 4.08% fixed rate (the current interest rate on private jumbos) would require interest-only payments of $3,400 compared to payments of $4,820 per month for a loan that required payment on both interest and principal.

2. What are interest-only mortgage drawbacks?

Despite the advantages, interest-only loans also pose significant risks to borrowers. Borrowers do not build up equity in their homes with interest-only payments. If home prices decrease, borrowers could find themselves “underwater,” or owing more than their home is worth.

Many lenders require larger down payments up front, which may total 30 percent or more than they would for a regular mortgage.

Elevated interest rates are often charged by lenders, with increases ranging from 0.12 to 0.25 of a percentage point higher than a traditional mortgage.

Interest-only mortgages come with adjustable rates, meaning borrowers risk seeing their mortgage payments increase if rates begin to rise. Borrowers should think carefully about whether they have enough liquidity, or available cash, to handle sudden increases in monthly mortgage payment amounts.

3. What is the best way to pay off capital?

Saving money throughout the mortgage term is the best way to pay off capital. When saving via an ISA or other savings scheme, you'll have a lump sum of cash that you can then use to repay the capital at the end of the mortgage term. 

Choose your savings plan wisely and make consistent payments and your money will grow, enabling you to reap even more financial benefits.

4. Is an interest-only mortgage right for me?

An interest-only mortgage may make sense if your monthly income varies or you're unsure what your financial situation will be like in the future. The built-in flexibility lets you save as much as you can when you can. If you expect to have more disposable income in the future, consider applying for an interest-only mortgage now. You always have the option to refinance into a repayment type of mortgage later on.

5. How to choose?

When making any mortgage decision, talk with someone who has experience with different types of mortgages to find the lowest mortgage rate.

Together you can decide the type of mortgage that makes the most financial sense based on your current and expected financial situation.

About The Author:
Gretchen Wegrich
Gretchen Wegrich is an editor at Lender411. She specializes in mortgage basics, personal finance and green living. She graduated with a bachelor's degree in writing from University of California, San Diego and previously worked at the Santa Cruz Sentinel. Contact her at gretchen@lender411com.

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