The interest only mortgage is a mortgage option to only pay for the interest for specific mortgage terms. Thereby, the borrowers pay less per mortgage payment. So, they can afford a home or a more expensive home. While interest only mortgage sounds like a great way to purchase a home, there are risks involve on interest only mortgage.
No home equity
The borrower pays only the interest on the mortgage. In most cases, there are no repayments on the principal for first few years. Without home equity, the borrower can not build wealth. The borrower depends on the appreciation of the home to build wealth.
Higher interest rate
Mortgage lenders know the risks on interest only mortgage. And, there is high rate of mortgage default on mortgage payment. To cover up the potential losses, mortgage lenders charge higher interest rate.
Adjustable Rate Mortgage with Interest Only Mortgage
The Adjust Rate Mortgage is a type of mortgage in which the interest rate varies. Mortgage lenders charge the borrower with the current interest rate. Let us say the interest rate fluctuates two percent. The borrowers pay two percent more on monthly mortgage payment. The worst case scenario is the interest rate goes up. And, the borrower could not afford to pay the monthly mortgage payment.
Buy more can handle
The affordability of the mortgage deceives the unsuspecting borrowers. Since the borrowers pay less, the borrowers look to buy another home, or more expensive home. The reality bites, when the interest rates rises, home market value declines, or time to repay comes.
Nothing lasts forever
Mortgage lenders expect the borrower to repay after interest only mortgage term. For example, the borrower locks the mortgage in interest only mortgage on five year mortgage term. At the end of five year mortgage term, the borrower pays the mortgage with regular or conventional way to pay the mortgage.
Home market value declines
The real estate appraisal tells the fair market value of the home. Investors are always on the look out to sell for profit. The investors buy a home with interest only mortgage. Meanwhile, the investors wait for the fair market value to rise. If the fair market value fails to rise up, the investor poses a potential loss.
And to summarize
The interest only mortgage was popular in the 1920s, until the depression came. Interest only mortgage slowly disappear. However, interest only mortgage is making a comeback. Only this time, the mortgage is interest only for up to 10 years. Mortgage lenders usually use 5, or 10 year mortgage term for interest only mortgage. Interest only mortgages are perfect, when home market value is on the rise, income is on the way up, and interest rate is low. The knowledge of the risks also reduce the risks on interest only mortgage. When the borrowers are beginning to see the risks, they know that it is time to boot out.
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