6 Takeaways on Interest Only Mortgage for New Home Buyers

Most people who buy a home with a mortgage get a loan where you pay principal and interest over the entire life of the loan. But there are interest only mortgage loans out there where you only make interest payments for certain time period, typically five to 10 years. Because you only are paying interest, your payments will be much lower than with the typical amortizing loan.

Interest only loans are appealing in some situations because the payment is initially much lower. Some of the reasons that people get interest only mortgages include:

#1 Buy a More Expensive Home

An interest only mortgage will allow you to get into a more expensive home than you could afford with a fixed rate home loan. Lenders determine how much you can borrow based upon monthly income as well as your debt to income ratio. With a lower payment on an interest only loan, the amount that you can borrow will go up a lot. If you think that you can afford a pricier property, and you are willing to take a risk that things may not go to plan, the interest only home loan can be a useful financial tool.

#2 Free Up Your Income

Having a lower mortgage payment can let you choose how to spend and invest your money. If you like, you can put extra money towards the mortgage in some months and make it similar to a standard, amortizing loan. Or, you can invest the money that you would have put into the mortgage into real estate or a business. If you are a house flipper, you usually are going to get an interest only loan, so you are able to put as much money as possible into renovations.

#3 Keep Costs Down

In some cases, the interest only home loan will be the only loan that you can afford. You may have chosen an inexpensive home, but you are still having trouble swinging the monthly payments. An interest only loan can give you the chance to stop paying rent.

But keep in mind that there are risks to an interest only loan. It is key to understand the difference between benefits to an interest only loan and just being tempted by a lower payment. An interest only loan will only work out if you use it right, as part of a financial strategy.

An interest only home loan can be a good idea if you have an irregular income, such as getting income through commissions and not through a regular paycheck. This can help you to keep your regular monthly payments low and help you to make big lump sum payments when you get paid a lot. But you have to make sure you really do follow through with this plan.

There also are some downsides to interest only home loans to remember:

#4 You Do Not Build Equity

You will not build any equity in your home when you are paying an interest only mortgage. You will be able to build equity if you make any extra payments, but the loan does not really encourage you to do so. You also will have more difficulty getting a home equity loan later if you need the cash for some reason.

#5 Risk of Being Underwater

Paying the loan down reduces your financial risk over time. While homes tend to rise in value over time, this is not always true. In the financial downturn, millions of people's homes lost value and they were underwater on their mortgage. If you try to sell, you may have to write a huge check just to sell the property.

#6 You Are Putting Off the Inevitable

Whether you get an interest only loan or a regular mortgage loan, remember that the day will come when you have to pay off that mortgage. Paying only interest for five or 10 years will just make that day more difficult because you will have to pay a lot more at that time. People tend to think they will be in a better financial position in X number of years, but there is no way to know that is the case. Many financial experts argue to just buy a home you can afford with a regular mortgage today.