For most types of mortgages, the monthly payments will comprise of a part of the interest and principal, so the borrower is paying off both at the same time. Interest only mortgages differ in that they let homeowners pay only the interest for a certain amount of time, usually from 5-10 years. During this period the balance on the principal does not change.
Reduced monthly payments are one of the biggest benefits to interest only loans. This gives buyers the power to afford more expensive homes that they thought might otherwise.
There are a few reasons why certain home buyers will take out interest only home loans. Buyers who utilize these loans typically fit the following descriptions:
Interest only loans were very popular during the housing bubble, and are still popular among qualified buyers. There are new rules in place enacted by the Consumer Financial Protection Bureau that went into effect in January 2014 that prohibit interest only mortgages from reaching Qualified Mortgage Status. Qualified Mortgage Status was created to ensure protection for lenders in case the loan goes into default. As of now, interest only mortgages are only offered to qualified buyers who can put a lot of money down, and have substantial liquid assets.
Interest only loans aren’t for every home buyer, yet for certain borrowers there are very good reasons to obtain an interest only mortgage loan.
Borrowers can find themselves underwater quickly on interest only mortgages since these loans don’t amortize. Buyers can prepare for this by putting a lot of money down on the home, providing immediate equity.
Once the initial interest only period is over, monthly payments can rise dramatically. Buyers must be confident that they can afford the payments once this time comes. There are tight requirements for interest only loans, and many borrowers cannot qualify or come up with a large enough down payment.