The Interest-Only Mortgage
Let’s start with the fact that technically there is no
such thing as an interest-only mortgage. All mortgages, including
mortgages structured as interest-only mortgages, eventually require
the repayment of all principal as well as the interest, so technically
there is no such thing as an “Interest-Only Mortgage.”
What is commonly and somewhat mistakenly referred to as an interest-only
mortgage is actually a mortgage with an interest-only method of
payment. This type of payment option is available on several different
types of mortgages, depending on your lender.
What makes an interest-only mortgage different from other types
of mortgages is that the repayment of the loan’s principal
is deferred to a later time and is generally due and payable in
one lump sum. For the first few years of an interest-only loan,
the borrower is required to pay only the interest portion of the
normal loan payment and make no payment whatsoever against the
principal. At the end of the loan period the full amount of the
original loan is then due and payable, typically in a lump sum.
The repayment of the principal of the loan can be handled several
different ways. The borrower can repay the principal of the loan
from personal funds or from funds provided by friends and family.
The borrower may choose to sell the property and pay off the principal
from the proceeds of the sale, or the borrower may choose to refinance
the property using a more traditional amortized loan at the then-prevalent
interest rate.
Interest-only loans can be structured with both fixed-rate and
with adjustable-rate mortgages (ARMs). An interest-only loan is
seldom for very long. Typically such loans are structured to last
for 5 years, 10 years or 15 years, although your lender may make
other arrangements.
Interest-only loans are not for everyone, and investors must
be cautious and realize that there are inherent and unknown risks
due to the uncertainty of future interest rates and the liquidity
of the housing market in the future.
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