Interest-Only Home Loans

With interest-only home loans, borrowers have the option of paying only the interest on their scheduled monthly mortgage payments. With the Interest-only (IO) option, borrowers pay on the principal when it’s convenient for them. Typically, IO options last for a period of five to ten years. Even though the borrower can opt to pay on the principal any time, it’s not required until the interest-only period has lapsed. However, if a borrower chooses the IO option each month, the principal balance on the loan will remain unchanged.

Interest Only Payment vs Fully Amortizing Payment

Example of what the difference in the two payments would look like:

If a 30-year mortgage loan of $100,000 at 6.25% is interest only, the required payment would be $520.83. Without the interest-only option, the loan payment would be $615.72 - a fully amortizing payment which pays off the loan over the term. The difference in payment of $94.88 (principal) would go towards reducing the mortgage balance.

Potential Benefits of Interest-Only Home Loans

Here are some of the potential benefits of taking out an IO mortgage:

• Interest-only mortgages can be good for first time home buyers. Many new buyers are used to paying rent which is typically lower than a mortgage payment. If the borrower can pay more than just interest on a given month, it would go towards the principal balance. 
• The IO term, usually five to ten years, gives borrowers more flexibility because they are not obligated to make principal payments right away. This gives those expecting significant increase in their salary, over the course of the loan, more borrowing power than they could have afforded with a fully amortizing loan.
• Having an interest-only loan can be an advantage for a borrower who plans to upgrade from a starter home to a bigger new house within a few years. During the early years of a fully amortizing loan, most of the monthly mortgage payment goes towards interest anyway.
• For borrowers looking to keep their cash flow for other investments that yield higher returns, the IO loan may be a good choice. The investments would need to yield a higher return than the interest rate on the interest-only loan.

Potential Risks of Interest-Only Home Loans

Borrowers should be aware of the potential risks involved with IO home loans. Here are a few things to keep in mind:

• Because new home owners are not building any equity with an IO loan, they may be adversely affected by the market conditions at the time they are ready to refinance or sell their house. Homeowners may have trouble refinancing if there’s not enough built up equity in the home or if the real estate market goes down, making it difficult to sell the property.
• IO loans are considered higher risk to lenders so borrowers are usually required to carry mortgage insurance.
• Interest-only loans carry higher interest rates because of the higher risk to lenders.
• If borrowers over-anticipate increases in earning potential, they could have difficulty paying higher monthly mortgage payments when the interest-only period has lapsed.

Before deciding on what mortgage is right for your new home purchase, you’ll want to compare all the different loan types that are available. For more information mortgages, visit the experts at New Homes Central Lending.

[tag]new home, new house, mortgages, interest-only mortages, IO home loans, interest-only home loans, IO mortgage, interest-only loan, IO loan[/tag]

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