Like any other big purchase, buying a home should only be done after you have done everything you can to make sure you are educated, informed, and ready. Nothing is more heartbreaking and gut-wrenching, not to mention just plain depressing, than taking on a six-figure debt only to find out that it wasn't the best kind of debt for you. Now, I know that some of you were taught, like I was, that debt is bad. So, half of that is true. There are two types of debt: those that are responsible and those that are not. In another article, I'll talk about irresponsible debt, but I think it's responsible to talk about responsible debt when it comes to buying a house. Most people think that buying a house is a good idea all around. Most people agree that the debt is a responsible one. There are, however, different levels of responsible debt that can be taken on when buying a house. Having said that, I'd like to talk about what an interest-only mortgage is, who it's for, what the benefits are, and what the long-term effects are.
What is a loan that only pays the interest?
Almost everything about an interest-only mortgage is the same as what it sounds like. There is a principle amount, and you will be responsible for paying back that loan. If you borrow $100 and only pay the interest for a while, you still have to pay back the $100 at some point. With an interest-only mortgage, you can pay only the interest on your loan for a certain amount of time. It doesn't change the basic idea at all, at least not until the time is up (usually 5 years).
Who should get an interest-only mortgage?
The interest-only mortgage is made for people who want to buy a home but don't have a lot of money or want to buy something that's too expensive for them. I think the buyer can't afford the house in both cases, but in one, they don't make enough money to buy anything, and in the other, they just want to live beyond their means. But the interest-only loan is still for both of them. This loan is also for people who are pretty sure that their income will go up in the next few years. This is because, unlike with a fixed-rate loan, the payments on an interest-only loan go up over time.
What's in it for me?
An interest-only loan has some really great benefits. Your monthly payment goes down because you are only paying the interest and not the principle. On an average size, let's say $200,000, it will save you between $175 and $200 in payments each month. That's a big difference for someone on a tight budget. On a loan for $1 million, the savings will be close to $1,000 per month. The problem is that after the first 5 years (or however long you've decided the interest-only portion will last), your payments will jump up and be higher than the constant payments on a fixed-rate loan. It's a great way to get something you can't afford right now but know you'll be able to pay for later. It's also good for someone who wants to buy a house and sell it a few years later for a profit, since the total amount of money spent on it will be less.
What will happen in the long run?
When you think about the long term, the interest-only loan starts to sound scary. Let's say you take out a $100,000 loan with interest only and start making payments. Since you are only paying the interest, your payment would drop from around $600 per month for a fixed-rate loan to around $500 for an interest-only loan. You keep doing this for five years, after which the remaining balance is turned into a loan with a fixed rate. You still owe $100,000, but instead of having 30 years to pay it off, you now only have 25 years. Over 30 years, you will end up paying between $8,000 and $10,000 more. If you don't plan to live in that house for 30 years, though, the long-term effects don't matter as much.
Conclusion
I think that an interest-only mortgage might not be the best choice if you want to buy a house that you will live in until you are old enough to leave it to your grandchildren. In the long run, it would be better to choose something else that won't cost as much in interest. But this is something to think about if you are young, move around a lot, or are trying to move up in your company. With this type of mortgage, you can buy a more expensive house, have a little extra money for improvements, and then sell the house a few years later for a big profit if your job moves you to another city. At first, it's a great way to save money, but if you do it for a long time, it can be a real gamble. And always sit down with a trained professional who knows your situation, your needs, and what you want. When it comes to your assets, they will be the best things you have.
