How Do Interest-only Mortgages Work?

Sep 6, 2018

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How Do Interest-only Mortgages Work?

Upon reading the title, rather than wondering how interest-only mortgages work many of you are probably thinking aloud, “how ‘can they’ work?” It’s a solid question – after all, borrowers are traditionally supposed to pay at least some portion of principal rather than on interest only. While true, there are instances in which an interest-only mortgage can work for some people. Notice we said, ‘some;’ because it’s certainly not for everyone but it’s still a viable option for some people’s situation. Before we delve into whether or not an interest-only mortgage is ideal for you, let’s learn about what these unique mortgages actually are.

What are they?

An interest-only mortgage is exactly as it sounds: a mortgage where only the interest is paid monthly – although paying the principal is optional (it could also be required via a hybrid mortgage – more on that in a moment). Such mortgages can be downright tempting due to their lower-than-normal monthly payments, but that doesn’t mean borrowers won’t have to pay the principal eventually. With an interest-only mortgage, payments toward the principal amount are not required month-to-month, the principal is going to come due one way or another – and it’s up to the borrower to be prepared to pay off the amount given the time allotted.

Why choose this option?

To give oneself enough breathing room to invest in a new property within the first few years. It’s an option that first-time homebuyers should pay attention to, though they need to be aware that it’s critical to be in a safe, strong place financially to be able to pay on the principal regularly over time (remember: the principal always comes due). First-time homebuyers have enough on their plate, and utilizing an interest-only mortgage in the first year to give new homeowners the option to invest and fix the home to their liking is a smart first step to making the new home a worthy investment. It also protects against any unforeseen problems that could arise within the first year, such as plumbing that must be replaced and a faulty HVAC system.
Starting a new business? An interest-only mortgage is worth considering for entrepreneurs that have little-to-no capital, or for those that simply want to keep their overhead as low as possible within the first few years of business to ensure the business succeeds. As with first-time homeowners, it gives the business owner the luxury of investing early and avoiding mistakes most small businesses make in their first few years; likewise – just as with first-time homeowners – the principal must be paid regularly sooner than later to avoid higher-than-usual mortgage payments in the future.

Is it right for you?

Possibly. Compare the cost of a traditional mortgage versus an interest-only mortgage to discover the advantages and disadvantages of both and how they apply to your situation. If you’re refinancing and you’ve been paying on your home for years then an interest-only mortgage probably isn’t going to do you any good – especially since you’ve already been building equity with a traditional mortgage. That’s another thing: if building equity from the start is important, reconsider an interest-only mortgage! You cannot build equity if you’re not paying on the principal amount, so borrowing against it will be a no-go. Moreover, a property can lose value over time (depending on the property’s location, of course), and if the principal is not being paid yet the borrower decides to move, they may be forced to pay off the remaining difference even after the sell out of their own pocket! Think very carefully before deciding whether or not an interest-only mortgage is the right option for you.
In the end, it all depends on your situation. If you need time to save up to qualify for a traditional mortgage by having a lower-than-average mortgage payment, consider an interest-only mortgage. That’s where we at Dunpar Homes come in! We offer a low-rate, three-year interest-only mortgage that is perfect for such a situation. Give us a call today, and allow us to provide you with a fair and honest mortgage that will allow you to turn your property into the dream home you’ve always wanted!

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