Interest-only mortgages are a relatively new addition to the selection of loan products offered by today's mortgage lenders. Once generally offered only to high-income men and women, today the interest-only option is an increasingly popular choice for middle-class consumers as well. When considered as part of an overall financial strategy, interest-only mortgages can make good financial sense. When you're ready to shop for your next mortgage, take some time to familiarize yourself with interest-only loans and the potential benefits they may offer you.
Definition
Just as its name implies, an interest-only mortgage is one in which the borrower pays only the interest due on the loan for a specified period of time, often three, five or seven years. At the end of that period, the borrower must begin to pay both principal and interest, just as with a conventional loan. The lower payments due during the initial period of the loan can make this mortgage an attractive option for several reasons.
More Income on Horizon
Many homeowners have found the interest-only mortgage to be an ideal way to afford the home they want even with a reduced or low income. Because the principal amount will eventually come due, these loans are good for men and women who expect their incomes to increase within a few years--for instance, if a non-working spouse intends to return to the work force, or if the homeowner is working toward a degree that will result in an increase in income.
Erratic Income
Interest-only loans are also popular with individuals who earn most of the income at irregular intervals, such as those in sales or employees who earn infrequent or irregular commissions or bonuses. These buyers generally enjoy the lower monthly payments during low-income months, while paying off portions of the principal when commissions or bonuses are paid, or setting aside those chunks of income against the day when principal payments come due.
Moving Up
Because no principal payments are due during the initial loan period, monthly payments are significantly less than with traditional loans, and home buyers can typically afford a much larger home as a result. When these loans were first introduced, this aspect made interest-only loans an attractive product for executives seeking a larger home to impress bosses and clients. Today, average home buyers are also taking advantage of these loans to enjoy a larger house. Because the monthly payment will increase dramatically when principal payments take effect, this can also be a good choice for individuals who expect their income to increase before that time.
Tax Savings
Because mortgage interest is fully tax deductible, within certain limits, investors who opt for interest-only loans can deduct all of their monthly payments during the loan's initial period before principal payments kick in. This is one reason why these loans have traditionally been popular with wealthy borrowers, who use the loans as an investment strategy.
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