Interest-only mortgages generally offer borrowers the ability to make a lower minimum monthly payment in return for paying a slightly higher interest rate than a comparable loan. They come in many varieties. The interest rate may be adjustable from the outset or be fixed for several years before adjusting. Five, seven and ten years are common durations for the fixed period. After the fixed period elapses, the borrower may or may not be permitted to continue making interest-only payments for a few years. Interest-only loans often have caps similar to adjustable rate mortgages (ARMs) limiting how much the interest rate can rise at each adjustment and over the life of the loan.
Interest-only loans have been enticing to borrowers who plan to sell their house after a few years and who are counting on the continued appreciation of real estate in their areas. Some borrower's have used interest-only loans to purchase a more expensive home than they would otherwise be approved for.
The worst case scenario for a borrowers with an interest-only loan is that they will be unable to afford the "payment shock" when the interest-only period expires while simultaneously being unable to qualify to refinance their mortgage. Payment shock can be particularly strong when the requirment to pay back principal is combined with an increase in interest rates. The minimum monthly payments could go up 80% or more. Borrowers may not qualify for a refinance if home prices in there area decline or their income or credit score goes down far enough to disqualify them.
Our Interest-Only Mortgage Amortization Calculator enables borrowers considering interest-only mortgages to examine the best case, worst case and expected scenarios so they can weigh them against their alternatives and decide what the best course of action is.