Interest Only Mortgages - Things You Should Know

Posted by Nick Niesen on October 29th, 2010

Interest-Only or ?Interest-First? mortgages have been around for quite some time now, but have recently been exploding in popularity. Originally offered primarily in the non-prime market, interest only mortgages are now available as conforming loans and can come as a feature on a wealth of loan programs, including adjustable rate mortgages, 40 and 50 year term loans, stated income loans, and to borrowers with credit scores as low as 540.

The first thing you should know about an interest-only mortgage loan before you commit is that YOUR PAYMENT WILL CHANGE. (read, YOUR PAYMENT WILL INCREASE). With an interest-only loan, your first payments are towards the interest, not the principal. After a set amount of time (traditionally, anywhere from two to fifteen years), the lender will require you to start paying back the principal along with your interest payments. As long as you are prepared for this payment adjustment, interest-only loans can be an extremely useful tool in financing, especially purchases. With a lower monthly payment, your purchase power increases when shopping for your dream home, and you can always re-finance down the road to a regular amortizing loan.

There are a few caveats to be watchful of. Some predatory lenders target first time homebuyers by telling them they can afford (on paper) that gorgeous seven bedroom mansion. The mortgage they may have in mind could have a fixed rate for only two years (and then increase 2-3%), be interest only for the first two to five years, and have a pre-payment penalty that would cost them thousands of dollars if they want to refinance or even sell in the first two to five years of the loan. Unable to cope with the payment shock, the new homeowners may be forced into a very uncomfortable financial position.

Interest-only mortgages are a viable for many people. Just make sure you do your research and understand all facets of the loan you are offered.