Inside the World of Interest-Only Mortgages

It should come as no surprise that the most significant fear borrowers possess involves the affordablity of their monthly mortgage loan bills. But what if we told you there was a way to greatly reduce these payments each month.

Is that something you would be interested in?

We’re speaking of interest-only home loans. Before you get too excited and sign on the dotted line for these resouces, however, let’s discuss the details of these adjustable-rate mortgages …

When you take out a traditional mortgage, you pay the lender a monthly amount that’s a combination of principal plus interest. The principal goes to repayment of the money you borrowed; the interest is what the financial institution charges for the use of the money.

However, an interest-only mortgage allows you to pay only interest every month for a fixed period of time - usually the first five to 10 years. Then, depending on the term of your loan, you have 20 to 25 years to repay all of the principal, plus interest.

You’re allowed to pay money toward the principal during the interest-only period, but make sure your interest is recalculated on the new balance.

An interest-only mortgage could be ideal for you if you are short of cash, but want to purchase a home in anticipation of an improvement in your financial circumstanes.

Also, consider mortgage refinancing with an interest-only loan if you’re experiencing a temporary fiscal squeeze - if, for instance, you or your spouse has chosen to go back to school, or one of you has decided to take a few years off with your children. Paying only interest for a few years could help you remain in your current home, even though you can’t make your conventional mortgage payments for the time being.

For example: you have a mortgage of $200,000, with an interest rate of 4.75 percent. With an interest-only mortgage and no principal payments due for five years, your mortgage payments for the first five years will be just $791 a month. With a regular five-year adjustable-rate mortgage and the same interest rate, you would pay about $250 more per month.

Because interest payments on your mortgage are generally tax deductible, you may be able to deduct 100 percent of your monthly payment, as well. Consult your tax advisor to confirm whether you are eligible to do so.

But remember: Monthly bills will rise tremendously after the initial five or ten year period. Only consider these options if you’re prepared to such an increase down the line.