A Closer Look At Interest Only Mortgages

Usually, when you pay off a mortgage loan, a part of your monthly payments is used to cover the interest owed for the past month, while the remaining part is deducted from the principal. In other words, your principal balance also decreases with each payment you make. This is, however, not the only version of mortgage loan available.

The so-called balloon mortgage, or interest-only mortgage, works in a different way. For the duration of the mortgage term, you will be paying only the interest due on the loan, without directing anything from that payment towards the principal. When the mortgage term ends, the sum you still have to pay will be the same as the amount you borrowed. By that time, you’ll have paid the interest in full and you can start paying off the principal balance of the loan. In the following paragraphs, we shall have a look at the benefits and drawbacks of this kind of mortgage loan.

The first obvious advantage is that your monthly payments will be lower than in the case of a traditional mortgage loan. That means you will be able to purchase a more expensive home than you could normally afford. No complicated calculation is necessary to understand this. It is obvious that the sum you will be paying in the case of an interest-only mortgage is more easily affordable than the one payment you would have to make to cover a regular mortgage loan.

Still, most financial advisors will not encourage you to choose a balloon mortgage. The choice may be a good one if you don’t intend to keep the loan for more than a year or two and if the lender offers you an irresistible interest rate.

Otherwise, the prospect of not building any equity into your home before the end of the mortgage term is not very attractive. Even after you have paid all the interest due on the loan, the home will still be considered fully financed.

A more subtle reason becomes evident if you buy your home during a high market. If the value of the home drops during the term of the mortgage, you may still have payments to make even after selling your home. Then you will have to come up with another plan in order to pay off the remaining balance.

It is always better to seek the advice of a realtor, but the general rule is not difficult to grasp. If you plan to live in the house for a while, the interest-only mortgage is probably not the best option for you.