When the Interest Only Mortgage is Right

By Gabriel Traverso
CMR Columnist

Some homeowners lately have attempted to stretch their new home dollars with an interest only mortgage but it isn't a move to be taken lightly. The interest only mortgage is right for savvy borrowers with specific objectives--are you one of them?

Understanding the Interest Only Mortgage

The interest only home loan is a mortgage that gives you the option of paying only the interest on the loan. However, this works in short-term situations and homebuyers thinking that an interest only mortgage will get them into their fantasy home with no repercussions need to be cognizant of the tradeoffs involved.

When is the Interest Only Mortgage Right?

There are a few circumstances where choosing an interest only loan might be right for buying a new home:
  • Fluctuating or increasing income. For example, a sales person paid on a quarterly commission with an annual bonus might choose this mortgage. Particularly if a big deal has just been closed and a big commission check is guaranteed. Home buyers on the brink of an income boost, such as medical students completing their residencies may want to take advantage of smaller payments at first, knowing that their incomes will keep up with future payment increases.
  • Expectation of large assets. Borrowers waiting for a lump sum such as a legal settlement or an inheritance can take advantage of lower payments now. When the big check arrives, the loan can be paid down, fixed, and re-amortized to drop the payments. While it is generally advisable to wait until the money is in your hand before you spend it, if you know it's coming the interest only mortgage lets you get into home right away--and keep your payment manageable while waiting.
  • Other more profitable investment opportunities exist. If you have the chance to invest the funds at a higher return than the interest rate on the mortgage then it might be better to divert as many funds as you can into the alternative investment.

Understand the Risks

It's important to understand how risky betting on the future can be. When you choose an interest only mortgage your payments won't touch the principal. You must be able at a later date to make large payments towards the principal or refinance the home loan. Contact a lender and see if this might be the right loan for you.

About the Author
Gabriel Traverso is a freelance writer, professional musician, and artist. He resides with his family in Reno, NV.

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