When researching your different options for a mortgage on your home, you might have heard of an “Interest-Only Mortgage”. What exactly does this type of mortgage mean and how does it work?
Usually when you take out a loan, you must pay back the capital debt (the amount you borrowed) and the interest on that debt. An interest-only mortgage offers a cheaper option for purchasing a property, because you’ll only be making payments on the interest and not the capital.
Compared to a repayment style mortgage where you are paying down the principle of the loan, an interest-only mortgage will have much lower monthly payments.
However, when you reach the end of the mortgage term with an interest-only mortgage, you will not have paid off any of the original principle of the loan. This means that you will still not be any closer to owning the home than when you started, whereas with a repayment mortgage you would be in full possession of the property. You will reach the end of the loan term, still owing the lender $250,000 or whatever the initial loan was. Also, if you do not pay off that lump sum at that point, the lender will charge you interest on the entire loan for the full time.
From the description of how it works, it seems like there would never be a good situation for taking out an interest-only mortgage. However, if you’re stretched financially and desperate to get onto the property ladder it might be a viable option. Some people take on an interest-only mortgage so that they can buy their first home, then when their income goes up they switch to a repayment mortgage.
Another common use is for sellers who have their home on the market, but don’t want to wait for it to sell to buyer their new property. An interest only mortgage can help borrowers qualify for both monthly payments until the original home sells. At that time, a refinance would be a great next step.
To find out more about mortgages and determine the best option for your needs when buying a home, contact your trusted mortgage professional or ask us for a referral.
Have other mortgage related questions? Let us know below!