What Are Interest-Only Home Loans?
Mortgage options are plentiful, and if you are thinking about financing a new home, you may consider an interest-only home loan. Interest-only home loans provide certain advantages; however, there are also risks associated with this type of mortgage loan. Know the downside, and then decide if this type of home loan is right for you.
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Definition
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Interest-only home loans differ from other types of mortgages. If you're financing your home loan with a traditional 30-year term, about 70 percent of your monthly payment will go toward reducing the interest charges on the mortgage, and not the principal, says Quicken Loans. Buyers who select an interest-only option will pay only interest during the first three to five years of their home loan term.
Advantages
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The primary advantage of making interest-only payments during the initial loan years is the ability to save money on the house payment. This payment method benefits borrowers who can't qualify for a specific loan amount based on their present income. Interest-only mortgages also help borrowers living in an overpriced housing market afford a house.
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Risk of Interest-Only
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Understanding the risks of interest-only mortgages is imperative. Because these mortgages only reduce the mortgage interest, the principal remains the same for the duration of the interest-only period. If you live in a market where home values do not increase due to economic factors, you lose the opportunity to build equity. And if your home value decreases, you risk becoming upside-down on your mortgage, owing more than the property is worth. Because interest-only payments are only temporary, lenders will request principal payments once the mortgage resets, and this change can cause a significant jump in your montly payment.
Who Benefits?
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Interest-only home loan options benefit borrowers who plan on living in their house for only a short period. Thus, they can sell the home before the mortgage resets and principal payments start. There's also the option of refinancing the mortgage to a fixed rate before the payment changes. Interest-only mortgage also benefit borrowers with the financial means to afford a higher payment in the future.
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