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You may have heard of an interest only mortgage as an option for lower monthly payments on your mortgage payments. With an interest only mortgage, your scheduled monthly payments are interest only. This means that for a certain period of time you only pay the interest charges on your loan. Pay close attention to the word “scheduled”. In indicates that the lender only requires the borrower to make a payment in the amount of the interest. The borrower is still able to payments higher than the interest if desired.
The result of an interest only mortgage is that during the interest-period of the mortgage, payments are not credited towards the principal of the loan. Therefore, the balance of the loan does not change during this period of time.
If you’re not paying down your loan balance, why would you want an interest only mortgage? An interest only mortgage is beneficial because the required monthly payment is lower than that of a non-interest only mortgage. Borrowers with fluctuating incomes benefit from making interest only payments. Some borrowers are able to qualify for a larger loan because the interest only option decreases the monthly payment.
Borrowers who use a second mortgage to finance their down payment often use the interest only mortgage as their primary mortgage since second mortgages usually have a higher interest rate. It makes sense to repay off the mortgage with the higher interest rate as quickly as possible. Using the interest only option for the primary mortgage frees up the capital to do this.
Borrowers should beware because this low monthly payment does not last indefinitely. After the interest only period has expired, your monthly payment to your mortgage will increase significantly, especially if you have not made any payments to the principal of the loan during the interest only period.
Let’s say you have a $360,000 mortgage with a 30-year term. Without the interest only option your monthly principal payment would be $1,000. However, if you have an interest only mortgage for 5 years, your monthly principal payment will be $1,200 when the interest only option expires. A 10-year interest only option will put the principal payments at $1,500 once the interest only period expires. The longer you have an interest only mortgage, the higher your principal payments will be when the interest only option expires.
The best way to manage an interest only mortgage is by making principal payments whenever possible. By doing this, you are decreasing the risk of having your monthly payments shoot up to an unaffordable level.
Even though you have an interest only mortgage, you may still see your interest payments increase during the interest only period. Why does this happen? Well, lenders only extend the option of an interest only mortgage with an adjustable rate mortgage (ARM) – one that has a fluctuating interest rate. If the initial fixed rate period of the ARM expires before the interest only period expires, you are subject to an interest rate increase which leads to an increase in your monthly payment. Similarly, your interest rate could decrease resulting in a decrease in your monthly payment.
Keywords: Interest Only Mortgage
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