Types Of Mortgages - Interest Only Mortgages
There are a surprising number of types of mortgages available for you to choose from. This can be quite confusing, especially for a first time home buyer. You have the choice of, depending on your country, fixed rate repayment, variable rate repayment, variable rate endowment, pension mortgage, and interest only mortgages.
The 'traditional' mortgage is the standard repayment mortgage, whereby your monthly payment includes both interest and a repayment of the capital loan. In the early years, your repayment is almost entirely interest, but as the loan becomes more mature the amount of capital you pay off each month increases steadily, to ensure that the entire mortgage is paid off in the term agreed at the start. Such repayment mortgages can be either variable interest rate or fixed interest rate; the fixed interest rate can be for the full term of the loan or, more usually in the UK, for between 1 and 5 years.
Another type of mortgage is interest only. This is quite simply what it says; you pay only interest on the mortgage. This means that you are not repaying any of the capital nor increasing equity in the house. The onus is on you to select a means to accrue enough capital, through savings or investment, to pay off the loan in a lump sum at the end of the term. In other words, if you have a $200,000 mortgage over 20 years, after 20 years you will still owe $200,000. But will you have that money saved to pay off the mortgage? That is the main question when considering an interest only loan.
Personally, I did like the idea of an interest only mortgage when I lived in England, and that was because I was confident I could make more with that spare money each month over the years, and be in a position to pay off the mortgage early. But then I was a keen stock market investor with formal financial training. Even so, I never took that risk. I would recommend the standard type mortgage at any time, but if you are tempted to try an alternative, you would be well advised to see a financial advisor in your own country.
The article below considers interest only mortgages a bit further.
Is An Interest Only Mortgage Right For You?
Over recent decades a new type of house mortgage has been developed for to consumers, and it is known as an interest only home mortgage loan. This type of mortgage, sometimes called a balloon mortgage, is an interest only mortgage, and it is exactly what the name implies. For the term of the mortgage, the borrower is paying only the interest that is due on the mortgage, and is not paying anything back towards the original loan amount. In other words, there is no capital repayment each month, so at the end of the mortgage term, the balance due on the loan will be equal to the full amount that was originally borrowed. This balance will be due, in full, when the mortgage loan term ends.
Why An Interest Only Mortgage Loan Appears Attractive
Obviously, we would all like our monthly mortgage payments to be as low as possible. With an interest only home mortgage loan, the borrower keeps their monthly payments to a minimum by paying only the interest that was accrued on the loan in the last thirty days since his last payment. Therefore, this type of mortgage is often marketed to the consumer as a tool which allows the borrower to afford a better home than they would be able to with a traditional home mortgage loan.
To illustrate this, let’s take a look at the purchase of a $300,000 home. To buy this home with a traditional 30 year fixed rate mortgage, with a 7% interest rate, would mean you had you monthly mortgage payments of approximately $2,000. Alternatively, if the buyer chose an interest only 30 year fixed rate mortgage, with the same 7% interest rate, monthly mortgage payments would only be $1390. This type of mortgage would be attractive to the consumer who can afford $1400 per month, but cannot afford $2,000.
Usually, however, an independent financial advisor will tell you it is best not to choose this type of interest only mortgage, except maybe in rare circumstances. Those circumstances may be, for example, if it you only intend to keep the mortgage for a couple of years, or if you are a very financially sophisticated investor who understands, and can satisfy the responsibility for, paying off the loan in a lump sum when the term is up.
Why An Interest Only Mortgage May Not Be Right For You
In general, it is better not to choose an interest only home mortgage loan. Why should this be? The largest problem with this type of financing is that the home owner is not building any equity into his home with an interest only mortgage. The home will still be considered “fully financed” even after the mortgage term comes to an end. You need to be absolutely sure you can accumulate a lump sum, at least equal to the amount of the loan, by the time the loan term expires.
There are also other reasons that an interest only mortgage is not usually your best choice. If you buy the home during a high market and the value of the house drops or remains the same during the term of the mortgage, it is possible that even after selling the home, you will still not be able to pay off the loan.
Furthermore, if then you do not want to sell the home, you will need another mortgage for the balance outstanding.
Overall, if you are buying a home and planning on living in it for some time, an interest only mortgage is probably not the best type of mortgage loan for you!