The interest only mortgage

3 reasons it might be right for you

Everyone’s home-buying situation is different. Some folks may have difficulty coming up with 20% down to avoid mortgage insurance. Some may have difficulty deciding whether they want a third home in Colorado or Maui. If you enjoy a healthy financial situation and you think your future financial situation will be the same or better, an interest only mortgage could be a good option for you and your family.

An interest only loan applies funds solely to the interest and not the principle of the mortgage for an initial timeframe, usually 5, 7 or 10 years. During this time, monthly payments are lower than comparable loans that put funds toward principal and interest. After the initial period expires, the principal portion of the loan kicks in and monthly payments can increase significantly. As with adjustable rate mortgages (ARMs), borrowers often sell the property or refinance before this happens.

How do you know if an interest only mortgage is right for you? There are a few scenarios that might make it an attractive home-buying option:

Selling soon

If you plan to sell the home a few years after buying it, an interest only loan might make sense simply because you get more square footage for less money. However, you’re never going to be able to control the local housing market, so if the home depreciates and your sale price comes up short of expectations, you’re still on the hook for the full balance of the mortgage.

Future funds

Perhaps you’re a promising lawyer on the fast track to making partner. Maybe you’re in the fifth year of a medical residency and soon will be striking out on your own as a fully trained surgeon. Maybe you work on Wall Street and enjoy huge year-end bonuses each December. Whatever the source of your future windfall, an interest only loan may be ideal for letting you pay less in the present, with the understanding that once the interest only period expires, you’ll have the ability to overcome significantly higher monthly payments. It may be tempting to make early bulk payments or pay off the loan in full before the interest only period ends, but some loans have a prepayment penalty that may discourage this strategy. As with any mortgage product, it’s important to research every detail carefully with your home loan expert before signing.

Best to invest

If you’re a stockbroker, fund manager, trader, financial advisor or some other form of money master, an interest only loan may accommodate an aggressive investing approach. Since the interest only payments are usually significantly lower than those of a conventional loan, financial wizards can take the money they don’t spend and inject it directly into an investment portfolio. This approach only makes sense when it outperforms the home equity value one would realize by paying down the principal of a conventional mortgage and selling at a profit. If the house is in a hot market, a more lucrative investment might be the property itself, not a mutual fund. To be sure, using “left over” money to build net worth through the stock market is a high-risk play that requires a lot of discipline, and is best left to those who really know what they’re doing.

An interest only loan is certainly not for everyone, but if you can identify with any of the life situations described above, it may be just right for you.

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