How Do Interest-Only Mortgages Work?

If you’re ready to buy a new home, it’s important to explore your options to find the best mortgage rates possible.

 

One option that you may not be aware of is an interest-only mortgage. Interest-only mortgages can be a great way to lower your monthly mortgage payments in order to increase your monthly cash flow for the first few years of your mortgage.

 

Before choosing this type of mortgage, though, it’s important to understand how it works and what the benefits are.

 

Let’s take a look at how interest-only mortgages work.

 

What is an Interest-Only Mortgage?

 

Essentially, interest-only mortgages allow borrowers to just make interest payments on their mortgage rather than interest and principal payments.

 

However, these interest-only payments typically only last for the first few years of the mortgage. After this fixed period ends, you have to start paying the principal and interest, which can increase your monthly payments by hundreds of dollars.

 

This caveat is one of the main reasons interest-only mortgages aren’t very common with homeowners. However, in certain cases, interest-only mortgages can be a good option.

 

How Does it Work

 

Interest-only mortgages are typically structured just like traditional mortgages. The primary difference is the interest-only payment period.

 

Interest-only mortgages often have 30-year terms with the interest-only payment period lasting for the first 10 years of the mortgage. During this period, you only have to pay the interest, which can be very beneficial for homeowners who need extra cash flow.

 

Once this period is over, you must begin making principal payments on top of the interest payments. It’s important to be prepared for this as the principal payments can add hundreds of dollars to your monthly mortgage payment.

 

When to Get an Interest-Only Mortgage

 

There are a few cases in which an interest-only mortgage can be a good idea.

 

First, if you’ve bought your new home before selling your old home, an interest-only mortgage can help you save some money until you finally sell your old house.

 

These mortgages can also be a good option for homeowners who want to free up more money to invest. By lowering your monthly mortgage payments, you can invest your extra income during the first few years of your mortgage.

 

It’s important to remember, though, that during the interest-only payment period, you won’t be building equity on your home. Additionally, if you decide to sell your home during this period, you will still have to pay the entire principal balance on your mortgage.

 

Tips for Paying Off an Interest-Only Mortgage

 

If you decide to take out an interest-only mortgage, it’s important to make a plan to pay off your mortgage as quickly as possible.

 

First, while the main benefit of these mortgages is the interest-only payment period, you should consider making principal payments whenever possible. This will help you pay off the mortgage quickly and build equity on your home investment.

 

Additionally, you should make as large a down payment as you can. Making a larger down payment will reduce the amount you have to pay in interest over the course of your mortgage.

 

Finally, be sure to review the terms of your mortgage with your lender. It’s important to understand when your interest-only period ends and how much your payments will be after this period is over.

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