Unlike most home financing, an interest only mortgage loan gives borrowers the option of not paying principal amounts until after a specific period, usually the first five to ten years. A typical fixed or adjustable rate mortgage is financed by multiplying the cost of the house by the interest rate, or finance charge, over the term of the loan, usually fifteen, twenty, thirty, or forty years. Mortgage payments reflect the computed principal and interest, or P&I. Lenders apply a borrower's monthly payment to both the outstanding principal, the amount of money financed, and to the interest, the amount charged to carry the loan. By applying payments to both principal and interest, both parts of the mortgage are gradually reduced month by month. However, with an interest only mortgage loan, only the finance charge is reduced for the first 60 to 120 months, while the principal balance remains the same. However, at the end of the interest-only term, P&I payments become due and the entire balance reduces each month as notes are paid.
First-time home buyers, investors, and those on a fluctuating income may all benefit from delaying principal mortgage payments, especially in a lagging economy. For buyers just trying to get into their first home, the savings realized by delaying principal payments can be sufficient to put some cash back into a tight budget. Coming up with a down payment, closing costs, appraisals and attorneys fees can be an expensive undertaking; not to mention moving expenses, furnishings, and utility deposits. An interest only mortgage loan can help first-time buyers get established in a new residence while getting accustomed to the cost of home ownership versus renting. Money saved can be applied to home repairs, lawn maintenance, homeowners' insurance, or unexpected expenses, such as replacing a furnace or installing new flooring. Salespersons, self-employed entrepreneurs, or home-based business people can take advantage of principal-free financing when fluctuating incomes are on the slim side. Mortgages provide the option of paying only on the finance charges during months when money is tight. Seasonal workers have a choice of making regular principal and interest payments when jobs are plentiful or switching to interest-only payments during leaner periods. This kind of flexible financing can actually give borrowers better leverage when it comes to personal money management.
Investors who don't plan on staying in a home for more than five years can also take advantage of an interest only mortgage loan. Savvy money managers can theoretically purchase a fixer-upper with this kind of flexible financing, make improvements to the property, and sell at a profit. Some states prohibit investors from "flipping" a house without occupying the property for less than six months. But five- to ten-year interest-only mortgages provide ample time for investors to rehabilitate, occupy, market, and sell a home for a substantial profit. Since principal balances remain the same, investor profit margins will depend on the sale price of renovated properties, less the cost of making improvements. Properties requiring mostly cosmetic and not structural renovations could wind up being gold mines for wise borrowers. Homeowners seeking to refinance and save may want to look at a principal-free mortgage as a way to get out of a high-interest fixed or adjustable rate contract. While the cost of initial financing may be slightly higher, the benefits of lowering monthly payments may be well worth refinancing in the long run.
The downside to an interest only mortgage loan is primarily the fact that principal balances do not decrease during the term borrowers are paying solely on finance charges. Mortgages with unpaid principles provide homeowners no equity until P&I payments resume. Owners can only realize a profit if the home appraises and sells for a price above the remaining balance. But in a housing market slump, property values are on the decline, and sellers may have to take a loss. Another disadvantage is that homeowners accustomed to making lower monthly payments for several years may not be able to keep up with heftier P&I notes, which may increase by two to three hundred dollars. That doesn't sound like much, but borrowers may have incurred additional expenses in the interim. A growing family's budget may not be able to withstand an increase of $200 per month without making major sacrifices. An adjustable rate interest only mortgage loan may require even greater payments at the end of the term.
Borrowers seeking to locate sources for an interest only mortgage loan can surf the Web or visit with local bankers and lending institutions. Many web-based lenders offer information on several types of mortgages and terms to help borrowers make the wisest decisions. Buyers should pay close attention to question and answer website pages where many personal concerns have already been addressed. And doing a little homework before approaching an online or local lender is just part of the financing process. A good credit rating is essential for any type of financing, along with proof of employment, residency, and income. Borrowers should be prepared to offer banking statements, federal and state income tax returns, and a listing of current creditors and unpaid installment balances. Online lenders usually provide applications and instruments to pre-qualify and assess a borrower's creditworthiness before completing the preliminary process. First-time home buyers and investors should carefully review terms and payment options for an interest only mortgage loan before committing to a long-term financial arrangement. Borrowers should also watch out for adjustable rate mortgages that tack on hefty interest rates, and make sure that they can manage higher payments a few years down the road. The potential savings of principal-free financing can be a boon to residential and commercial buyers with careful financial planning and an accurate picture of future fiscal obligations.
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