What Is an Interest-Only Mortgage? | Financial Terms

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Interest-only mortgage is a mortgage, just like the name says where you're only paying the interest. Now, most mortgages, part of your monthly payment, is part principle, and part interest. But, with the interest only mortgage all you're paying is the interest and that means that you are not paying down the loan at all. You're just kind of surviving and treading the water. So, these types of mortgages tend to be a lot riskier for folks, than a traditional mortgage where you're paying down the balance over time. Interest only mortgages also might have adjustments, where the interest could go up and down. So what happens now? And again, these come in all varieties, but let's take a five year interest-only mortgage. For the first five years, my interest rate, and mortgage are much lower than traditional mortgages. But what happens after five years? First, that interest rate could go up and down. Second, I have to start usually paying back all that principle that I haven't been paying. And, so while an interest-only mortgage might give you the lowest payment now. It can pose the most amount of risk for you in the future, because your payment can go up substantially, and so imagine if I were paying two thousand dollars a month on my mortgage, and all of a sudden my payment goes up to three thousand dollars. In a lot of cases that can become unaffordable for the homeowner. That is something to be really careful of. Now it's not all bad on the interest only mortgage. Let's take my situation. If I'm an investor, and I'm buying a home and I want to fix it up and sell it six months later, maybe I do want to keep my monthly payments as low as possible so that I have money for renovations and things of that nature. In that case, an interest-only loan may be very appropriate. I'm keeping my cost low, and again I don't care about what happens in the future, because I'm not going to be owning the mortgage, I will have sold the property by then. So again if you are considering an interest-only loan, really be cautious here. Make sure you know all the terms of that loan when the interest rate can go up or go down, when you have to start paying back the principle, and make sure it's appropriate for your situation.