Interest-Only Mortgages: Is One Right for You?

A recent trend in mortgage financing is to offer consumers “interest-only” loans. Many borrowers are attracted to this option because it significantly reduces their monthly payment by allowing them to pay only the interest on their mortgage for a set period of time, such as five or 10 years.

However, there can be drawbacks that should be considered before putting one’s home on the line with this type of mortgage. Be sure you have considered all the pro’s and con’s to make the right decision before you choose this type of mortgage.

What about building your home’s equity?
Think about the major reasons people decide to become homeowners in the first place. Buying a home is a good investment. It allows you to build equity through appreciation of the home’s value and by paying down the principal on a mortgage. When the principal is taken out of the equation, less equity is earned.

While your home may appreciate over time, there are no guarantees that the real estate market will perform as predicted or hoped. It’s important to ask yourself if the rate of appreciation will be enough to both pay off the full amount of the mortgage and to make a down payment on the next home you’d like to buy, when the time comes. If not, you may be basically starting at square one, with little to show for the payments you’ve been making, almost as if you had been paying rent.

Where will the extra money go?
Consider what you will do with the extra money you’re not paying into your mortgage, so it doesn’t end up as just extra spending money. Will you use it to save up for a down payment on your next home? If so, investing the money in a higher yield investment or savings option may be a smart move. Of course, the level of risk of the investment should be considered.

Another use for the extra money may be to pay off high interest debt, such as credit cards. This could also be beneficial, but only if you are truly diligent about reducing debt. If you charge the card back up after paying it off, you’re right back where you started. It could become a dangerous cycle — with your home as the casualty.

Can I really afford this home?
A home with more square footage or a move to a new neighborhood can be very enticing. Using an interest-only loan to purchase a home you otherwise would not be able to afford can be dangerous territory, though.

If for some reason you are not able to move out of the home by the time your interest-only period ends, the large spike in your monthly mortgage payment could be a financial burden you’re not ready for.

There are other beneficial options for consumers not planning to stay in a home long-term, such as an adjustable rate mortgage with a fixed low rate for five or more years.

Contact a financial advisor or mortgage lender you trust to find out more and help you decide what type of mortgage is right for your situation. Extra Credit Union's Real Estate Specialist can be reached at (586) 276-3000.

© 2009 Extra Credit Union