During the interest-only period, monthly payments are significantly lower than if you were approved for a traditional amortizing loan.
How are interest-only mortgage payments different from those of a traditional loan?
To understand how an interest-only loan works, keep these definitions in mind:
Monthly payments on interest-only loans are relatively low since the principal is excluded during the loan term. Borrowers will then have to start paying the principal interest once the interest-only term expires, which is usually after 5 to 10 years. This means that higher monthly payments will still occur after the interest-only period.
How do you calculate the payment on an interest only loan?
The calculation of payments for interest-only loans is pretty straightforward. The loan balance is simply calculated by the interest rate.
For example:
You must also make sure that you fully understand the terms of your agreement, as this varies among lending institutions. The key is to be aware that interest rates are usually variable, and will adjust regularly according to the terms of your mortgage.
Who are interest-only loans for?
You’re an investor who receives dividends in quarterly or semiannual payments, or a high net worth individual who wants to maintain liquid assets for higher yielding investments.
You’re a young professional who is confident that your income will considerably increase by the time the loan reverts to a conventional mortgage with higher payments.
You’re a short-term homeowner planning to refinance or sell your home before the interest-only term expires, who prefers to have cash on hand rather than build equity.
These are just some situations in which interest-only mortgages can be a good idea. Still, borrowers must fully understand the risks involved in taking this kind of loan. Investors, for example, should make sure that they really invest the difference they save from low mortgage payments. Young professionals must be realistic about their future income, since optimism doesn’t always translate into money. There is also the risk of a market collapse, in which case first-time homebuyers cannot expect low interest rates.
Interest-only loans may not be ideal if you are a standard home buyer who wants to pay less on your monthly repayments. You’ll only end up paying more in interest over the years, since low monthly repayments on the principal will translate to higher loan interests over time.
How can I qualify for an interest-only loan?
The mortgage industry has started implementing stricter qualifying processes with tougher requirements. But if you have done your research and are sure that an interest-only mortgage is the best option for you, consider taking the time to consult with a professional or ask your agent to walk you through the process.
