One option when evaluating a home loan or line of credit is to pay the interest only for the first several years of the mortgage. This means that you lock in an interest rate when you close on the transaction, and for generally the first five to ten years, you are not obligated to pay anything more than the interest on the loan. You will pay this monthly, just as you would a standard (full-amortizing) mortgage, and you can choose to pay money toward your principal balance each month if you have it available to you at the time.
Despite appearing like good deals, these types of loans are highly controversial right now. That means it is especially important to evaluate the pros and cons before deciding on an option.
There are several types of people for whom an interest only loan can be a reasonable and even favorable choice. If you are disciplined enough, dont have credit problems to make consistent payments on the principal even though you have no obligation to do so, an IO mortgage may save you money over the long-term.
You may also be a good candidate if you are able to increase your wealth more rapidly by investing your excess income rather than paying down the balance on your home. Though this is more rare -- most people do better to pay off their houses -- if you have a solid investment portfolio, you may find that you earn more by putting your extra income toward those investments.
You may also want to take an interest only loan in order to avoid “trading up” from a starter home in a few years. This can be a good consideration, especially given our current real estate market. The average American purchases a first home with the intention of buying a larger or nicer house within a few years, expecting by then to have a more stable job with a higher income. Rather than dealing with the considerable challenge and expense of buying, selling, and moving all over again, some individuals are choosing to buy a higher quality “second home” and bypass having a starter house. An interest only mortgage can help to keep your payments on the lower side while you wait for your income to catch up to the house you are buying.
Perhaps these scenarios sound risky to you. That’s because they are -- getting involved in this type of borrowing situation can be fiscally irresponsible. There is always a risk that your income will not increase as expected, that you may find yourself without a job and unable to pay when your lender begins demanding fully-amortizing payments, or that the investments you’ve prioritized above your mortgage will not yield the income you expected. If you dislike risk or simply feel unprepared to meet the obligations of a loan like this, do not accept one.
If you do feel that an IO loan is the right choice for you at this time, you are invited to request a free quote from one of our agents and compare your options so that you can make a smart decision for yourself and your family.