An interest only mortgage allows the home owner to buy a home that is more expensive than they could originally afford. However, interest only loans can be tricky because the borrower is only paying interest on the principal balance. With all home loans, the interest and a principal amount will need to be paid off. With interest only loans, the interest is the only amount paid off for a certain amount of time, usually between five to ten years. With that being said, the principal amount will remain unchanged until the elapsed time period has expired. At that time, the payment on the mortgage will then include the interest and the principal amount, making the mortgage higher.
People who typically choose interest only loans are:
An interest only mortgage is great for buyers who want to leverage their money elsewhere instead of locking it into a house payment. These home buyers are able to purchase the house of their dreams or investment property with a low mortgage payment. However, there can be interest only mortgage disadvantages as well. Keep in mind, that the mortgage payment goes towards interest and not the principal of the loan. Because of the unpredictability of the housing market, these home buyers can quickly find themselves underwater if the housing market drops. The tricky thing with these loans is that lenders and real estate agents do not know when the home prices will go up or down. One way home buyers can protect themselves with an interest only mortgage is by making a large down payment on the home to gain instant equity.
Remember that once the interest only time period expires, the buyer will be responsible for the principal as well as the rest of the interest. This could essentially balloon the home buyer's payment to something that they cannot afford and the loan could go into default causing foreclosure.
Interest only loans were extremely popular during the housing boom in the early 2000’s. Since the crash of the housing market, new rules have been put in place and went into effect in January 2014. Interest only mortgages are banned from Qualified Mortgage status, which currently is designed to protect lenders against liability if the home owner defaults on the current loan. This means the home buyer will only get approved for the loan if they are very well qualified with a high credit score, substantial assets, and can provide a large down payment.