November 4, 2021
  • November 4, 2021

Should you take out an interest-only mortgage?

By on June 23, 2021 0

Interest-only mortgages can provide flexibility for homebuyers, but not everyone. (iStock)

When looking for a home loan, an interest-only mortgage is one option you might want to consider. This type of mortgage does not require you to make any principal payments up front. Instead, you just pay the interest on the loan.

This is a big difference from a traditional 30-year fixed mortgage, which amortizes principal and interest over the life of the loan. If you’re interested in an interest-only loan, the tips below may help you decide if it’s right for you.

To explore your loan options, visit Credible to compare current mortgage rates and lenders.

How do interest-only mortgages work?

Conventional loans require you to make interest and principal payments for a fixed term, usually 15 or 30 years. At the start of the loan term, most of your loan payment goes towards interest. When you near the end of a 15-year or 30-year mortgage, most of your payment goes to the principal balance of the loan.

Interest-only mortgages allow you to make interest payments during the first part of the mortgage term. For example, you could make interest payments only for the first five to ten years. Interest only loans can have mortgage rates which are fixed rates or adjustable rates. After the initial interest-only term ends, you will continue to make payments for the loan, with both principal and interest being amortized.

An interest-only mortgage is a type of non-conforming home loan. This means that they are not supported or insured by Fannie Mae or Freddie Mac. Interest-only mortgages are less common than other types of home loans, and not all financial institutions offer them. You can contact Credible’s experienced loan officers to get answers to your mortgage questions, including more about how interest-only mortgages work and the types of mortgages available to you.

4 STEPS TO CHOOSING A MORTGAGE LENDER

Should you take out an interest-only mortgage?

Obtaining an interest-free home loan can offer benefits for some buyers, although there are some considerations to keep in mind. It helps to weigh the pros and cons in deciding if this is a good fit.

Benefits of Interest-Only Mortgages:

  • Lower payments: Since you only pay interest initially, your monthly payments may be lower than with a traditional 30-year mortgage.
  • Preserve money: Lower monthly payments can leave you with more money to invest or spend on home improvements.
  • Repayment of principal balances is optional: Although you are not required to pay anything for your loan principal balance during the interest-only period, you can choose to do so to reduce what you owe.
  • Potentially easier qualification: Since interest-only mortgages are not subject to compliant lending rules, lenders can set their own guidelines for borrower approval.

Disadvantages of the interest-free mortgage:

  • More expensive: An interest-only mortgage may not affect what you pay for the down payment or closing costs, but you may be paying more interest over the life of the loan.
  • Slow to build equity: Since you pay nothing for the principal of the loan, you do not accumulate any equity through your payments during the interest-only period. The positive side is that rising home prices increased home equity by 16.2% in 2020, according to CoreLogic. It can help you increase your home equity even if you don’t pay off the principal.
  • Higher Payments Later: Once the interest-only period is over, you could see your monthly payments increase dramatically.
  • Lump sum payments: Depending on how your mortgage is structured, you may need to make a large lump sum payment at the end of the loan term.

HOW TO KNOW IF YOUR HOME IS TOO EXPENSIVE

Are you eligible for an interest-only mortgage?

Since interest-only mortgages are not guaranteed by the government, lenders can set their own standards for approval. For example, lenders may accept borrowers with lower credit scores if they have a stable monthly income, substantial savings, or higher equity.

But is an interest-only mortgage right for you? You might want to consider this type of mortgage if:

  • You buy the house as a short-term investment
  • You need money to pay for home improvements or renovations
  • You plan to prepay the mortgage
  • You need a temporary mortgage option because you are buying a new home while selling the one you are currently living in
  • You are getting divorced and need a short term mortgage solution to buy out a spouse who is part owner of the property

You can also consider an interest-only mortgage if you are confident that you can refinance a conventional loan down the line. Credible can help you compare multiple mortgage lenders at once and see your loan options in just a few minutes.

DO I NEED TO REFINANCE MY MORTGAGE TO CONSOLIDATE THE DEBT?

Final thoughts

There are many pros and cons, and interest-only mortgages are not for everyone, but they can offer great benefits to those who qualify. And qualifying for these loans might be easier as they are not conforming loans and backed by Fannie Mae or Freddie Mac. If you’re looking for lower monthly payments, easier qualification based on your credit history, or short-term cash savings, an interest-free home loan might be the right mortgage option. You can use Credible’s online mortgage calculator and other tools and pre-qualify today.

Have a finance-related question, but don’t know who to ask? Email the Credible Money Expert at [email protected] and your question could be answered by Credible in our Money Expert column.


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