APRIL 15TH, 2024

Interest Only Mortgages and Equity Creation

An Interest Only Mortgage is an option that provides one to spend the beginning portion of the payment term (the length is stipulated in the contract), paying the interest on the loan. Next, one could begin to pay off principal, pay the total balance, or refinance. Perfect product if one plans to refinance after a short period. Interest Only payment plans are for consumers who anticipate earning substantially more in a few years and wish to maximize their purchasing power now or who will invest the difference between an interest only and an amortizing mortgage payments, and who also are quite confident their investments will earn money.

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These mortgages are further defined as an “interest–only payment option” which is offered on fixed-rate or adjustable-rate mortgages as well as on an Option ARM. This option to allow consumers to pay “interest only” provides that the consumer would only pay the interest portion of their monthly payment for a fixed period. At the end of the fixed period, the loan becomes fully amortized, thus resulting in highly increased monthly payments. Consumers should note that the new payment will be higher than it would have been if it had been fully amortizing from the start. The longer the period of “interest only”, the higher the new payment will be when that period ends.

Product is not useful for building equity nor is it a good choice for those with fixed incomes who may not be able to make higher payments after the interest only period. Here is an example of how “equity creation” of an Interest Only Mortgage might be possible. Since these type loans are not known for building equity, a consumer could potentially bank on an increase in appraised value of the property to identify equity. As an example: A consumer has a $200,000 Interest Only mortgage that is valued three years later at $220,000, thus the implication of acquiring $20,000 in equity creation.

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Why Should a Consumer Consider an Interest Only Mortgage?

It assists consumers in purchasing houses that are normally higher than their budget allows because it does allow a consumer to obtain a larger loan. Since the monthly payments will increase substantially after the interest only period, it is vitally important that the consumer will either sell after the interest period, or else expects to have a significantly higher income at that time. Consumers should also be aware there is risk involved; for example: should the consumer elect an extensive period for the interest only term, the market might change significantly and the consumer might not be able to sell the home for the amount they have planned.

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