Looking to Save Money with an Interest-Only Mortgage? Consider This First

• Author: Monica Jackson
• Posted: 2024-03-10

Continued low-interest rates are making it more attractive than ever to lock in a mortgage. Many borrowers are increasingly looking toward interest-only mortgagee to take advantage of these historically low rates. However, these types of loans are not for everyone. Here is what you need to know about an interest-only mortgage and how to decide if it is a good choice for you.

The Ins and Outs of an Interest-Only Mortgage

Despite its name, it is important that consumers understand that an interest-only mortgage does not mean that you never pay interest on the loan. While the loan can be structured in various ways, the distinguishing feature is that the borrower does not pay interest for a designated period of time. This is generally a time period ranging from three to 10 years. The goal of this type of loan is to lower the monthly payment on the front end of the mortgage compared to a traditional mortgage.

Before you sign on the dotted line, it is important to understand the ins and outs of this type of mortgage. Whether it is a good choice for your personal needs depends on your current financial situation and where you see yourself a few years down the road.

Advantages of an Interest-Only Mortgage

This type of loan may be a good idea for borrowers who know that they may be able to make bigger payments in the future but are strapped for cash currently. Examples of this would be an individual who is currently finishing law school or medical school. While they do not have a significant amount of cash on hand currently, they will likely be making substantially more money in a few years. If you are confident about your financial picture in a few years, this type of mortgage can free up cash in the near term when you need it the most.

If you have a healthy financial portfolio, an interest-only mortgage may be a good investment practice. Because mortgage interest is generally tax-deductible, this type of loan is useful when you are looking to lower your tax burden. The money that you are not paying toward the principal can also be used to fund other pressing financial concerns, including retirement accounts or college tuition.

Most interest-only mortgages do not penalize you for paying extra toward the balance each month. This means that you can put money toward the principal when it is convenient for you. This type of arrangement may be useful if your salary varies from month to month. Buyers who see fluid paychecks often like the flexibility of being able to pay more toward the balance when they are able to without being locked into a big payment.

Disadvantages of an Interest-Only Mortgage

There is no getting around the fact that an interest-only mortgage can be risky. It is important to know that most lenders will require that you place a larger than average down payment to offer up collateral. This type of mortgage is also risky if home values are not steadily rising in your area. A housing market collapse could leave you in financial ruin if you have not paid off any of the principal on your mortgage.

Many of these types of mortgages come saddled with variable interest rates. Although you may be tempted by today's low-interest rates, it is vital that you understand that this rate could increase exponentially. Unless you plan on selling your house soon, you should not count on the rate that you lock into to remain the same throughout the duration of the loan.

Interest-only loans also come with stricter qualifications than traditional types of financing. This means that your finances need to be in nearly perfect order if you want to qualify for this type of mortgage. Some lenders also offer these mortgages on jumbo loans, making them available to a small number of borrowers.

These are uncertain times. With the COVID-19 health crisis still surging around the country, there is an increasing amount of economic uncertainty. This makes it no surprise that borrowers are looking for ways to cut costs on their mortgages. However, it is vital that you think of the long-term implications when you consider the mortgage options available to you.