We have all heard all the advertising and press about interest-only mortgages. All we hear though is the wonderful benefit it is to have a low, low mortgage payment.
But, before you decide to run out and take advantage of these buy-now-pay-later ... and that is pay 'big-time' later mortgage programs, take a moment to enlighten yourself more about these so-called wonderful mortgages. Think about the basic premise: if you pay only the interest due each month, will you ever start paying on the principal and earning equity in your property?
By definition, a mortgage is a temporary, conditional pledge of a property to a creditor as security for performance of an obligation or repayment of a debt. Simplified, that means you borrow money from a financial institution and they essentially buy your house for you and you pay it all back in the future. How can this happen if you are paying interest only? More accurately, interest-only mortgages are a temporary reprieve from paying off a traditional mortgage. You are actually prolonging the inevitable and eventually you will be paying it even more costly to pay off your mortgage. "But wait, there is more..."
Far too many people are in debt way over their heads and interest-only mortgages have compounded the problem. They took advantage of the attractive offers to buy more house now and pay later. With the interest-only mortgage, you are keeping the mortgage principal at the same maximum balance and paying interest on the entire amount for the designated interest-only period (typically five to 10 years). With the more traditional mortgage, you'd be slowly paying less and less interest every single month. (and interest-only mortgages are a higher rate of interest to begin with).
Most interest-only mortgages are offered on adjustable-rate terms (although they are offered on some fixed rate programs as well). Interest-only payment periods are not for the entire term on the loan either. They are typically 3, 5, 7 or 10 year periods. What most borrowers don't understand (and/or are in denial about) is that when the interest-only period is up, their payments go up dramatically more than they expect. Why? Not only do you have to begin to pay principal AND interest, but you have to pay it back in the remaining term, not in the original 30 years. Now you may have to pay back that entire original principal amount, plus interest, but now in a muck lesser term... maybe as little as 20 years instead of the 30 years the typical mortgage is amortized over.
Conversely, interest-only mortgages can be a decent option for some borrowers. Those would include people planning on moving is say less than 6 or 7 years; or those buying more home today than they may have but only because they were insured of a greater income in the very near future.
The risk is in the real estate marketplace itself. If the current trends continue and we not only have slower markets but in many many areas, a declining market in values of homes; the interest-only mortgages could prove disastrous for some, as they would have no equity and may owe more then the home is actually worth. Be sure to read the fine print in the mortgage terms (and there is a lot of it) before deciding on any mortgage program... interest-only or not.
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