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Interest only mortgage is not as popular as repayment mortgage. Some people may not even be aware that interest only mortgage exists. For the purpose of those who may not be familiar with the term, I will like to quickly explain what it means.

When you take a mortgage loan, ordinarily, the loan will have to be spread over the mortgage term in equal installments. The monthly payment will comprise both interest and the principal repayment. For instance, if you take 30 year fixed mortgage, the loan will be spread over thirty year period in equal monthly installment. It means that you are going to pay the same amount over the entire mortgage period. The only variation is when your mortgage is adjustable rate mortgage (ARM) where the interest rate can be adjusted. Any time the mortgage rate is adjusted, the monthly payment may change to reflect the new interest rate. The type of mortgage whereby you will be paying back both the interest and the principal all through the term of the mortgage is known as repayment mortgage.

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Another type of mortgage is the ‘interest only mortgage’ in which you are only required to pay the interest element of mortgage for a specified period, usually 10 years. During the interest only period, you will only need to pay the interest alone while the main principal remains. For instance, if you obtain 30 year fixed mortgage of $150,000 with the interest-only option for ten years, your monthly payments for the first ten years will just be interest on the mortgage alone. At the end of the tenth year, you will still have your complete $150,000 mortgage principal outstanding. You will then have 20 years left to pay both the $150,000 and the interest thereon.

In this article, we shall discuss why interest only mortgage may be ideal for some people, its advantages and disadvantages.

Suitability of Interest Only Mortgage

• Flipping: If you are buying a home with the intention to sell quickly, you may not want to invest too much in the property. If your main objective for buying the home is to maximize your returns on the little amount invested, then you may go for interest only mortgage. Your monthly commitment will just be the monthly interest. And this will be much less than when you need to also pay part of the principal as in the case of repayment mortgage. For this to actually work out properly, it will be good if you can sell the property before the expiration of the interest only period. You may not wait till you are approaching the end of the interest only period before you starting looking for potential buyers.
• Low income: If your current income is low but you are optimistic of earning higher income in the near future, it makes sense to start paying the interest amount only. With this, you won’t put too much pressure on yourself as your current low income may not be able to pay both interest and principal on a monthly basis. A good example is when you are running a course that you know will enhance your earnings potential when completed. This scenario will work perfectly if you are certain of landing a better job if your current employer will not be able to pay you the higher salary you desire.
• Present Commitment: If you already have things you are spending money on now, you may not be able to add other commitment that will lead to much cash outflow again. In this case, it is not that you don’t earn good income. But you are currently spending the money on some viable projects which will be completed in the near future. Example is when you are making monthly payments on existing home. Or it may be that you are spending money in sending your children to schools. After few years, you must have paid all the mortgage on your existing home or your children must have graduated from University. At this point, you will be able to divert the money you have been paying on these project to paying monthly obligation on the new mortgage. Paying for interest and principal may no longer be difficult then.
• Invest in other assets: Opting for interest only mortgage may afford you to buy two home at a time instead of one. The money you would have been paying for principal repayment could be used to pay interest on the second home if they are both interest only mortgages. On the other hand, you may be able to find other investment opportunity that guaranties you higher returns. So, instead of tying money down on one home, you can invest the money on other asset with high returns.
• Convenience: Interest only mortgage affords you to pay principal when convenient. During interest only period, you can still pay down the principal if you have unexpected income. However, you may like to ask your lender if their interest only mortgage attracts penalties when a borrower prepays.

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Advantages of interest only mortgage

• Lower monthly payments: The main advantage is that, you will only need to pay the interest portion of the loan as long as the interest only mortgage term last. So, you don’t need to wait till the time you earn huge income before you buy your dream home.
• Enhanced buying capacity: The interest only mortgage allows you to buy more than you can actually afford right now. This can be in term of quantity or value.
• Tax incentive: During the interest-only period, the whole amount of the monthly payment (for mortgages up to $750,000) qualifies as tax-deductible.

Disadvantages of interest only mortgage

• More interest payment: Making lower monthly payment all through the interest-only period makes the mortgage more expensive overall.
• Not building equity: It is not that you are not paying your monthly instalments. Unfortunately, the payments do not count as you are only paying the interest on the loan while the principal remains. Therefore, you cannot even take advantage of any equity to apply for home equity line of credit (HELOC)
• Home value may decrease: If your aim is to quickly sell the property so that you can realize gain, you may be disappointed as there is no guaranty that the value of the home will increase. If the value of the home decreases, you may end up selling at loss. If you don’t want to sell at loss, you may need to wait for longer time than the interest-only period. To make things worse, your income may not be able to support the payment of interest and principal.

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• Risk of foreclosure: If you can’t meet up with the increased monthly payment after the interest-only period expires, your lender may force you to sell the home. This may result to loss or you are unable to maximizing profit on the property.
• May not invest the difference: Paying only interest will allow you to have some extra cash available to you. Some opt for interest-only mortgage with the intention of investing the extra cash in other assets. Unfortunately, they may end up lavishing the money on things that don’t actually add value.
• Expected higher income may not materialize: If you are anticipating higher income, it is just a projection. That is, it is a game of probability. Only today is certain, you cannot predict future accurately. That makes interest-only mortgage a risky one.

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