More and more people are requesting interest only mortgage loans every year. The Council of Mortgage Lenders has reported an increase on the requests of these loans of up to 20% in the last few years. However, before jumping in to request these low monthly payment mortgage loans you need to fully understand what they are and how they work.
Interest only mortgage loans are becoming very popular especially for first time home buyers who request these loans due to not being able to afford the monthly payments of regular mortgage loans. What these first time home buyers ignore is the risk that these loans carry with them that could jeopardize repayment and endanger the property exposing it to repossession due to sudden changes on the monthly payments that can cause a default.
Interest Only Mortgage Loans
As opposed to regular mortgage loans which payments are composed both of capital and interests, Interest only mortgage loans carry only interests during the first part of the repayment program. This implies that for the first few years, the mortgage monthly payments can be kept low enough to be afforded with almost any budget.
However, at some point, the borrower needs to start repaying the capital portion of the loan. Thus, these loans are useful for those who can not afford high monthly payments right away but know that they will be able in the future or that they will have the money needed to pay off the whole loan’s principal when the loan is due.
The Interest Rate Variation Issue
One problem that may rise when choosing variable rate mortgages is that since the payments are composed fully of interests, a variation of the interest rate affects the amount of the monthly installments significantly and thus, an increase on the interest rate can skyrocket the monthly payments leaving the borrower unable to afford them.
That’s the reason why, whenever possible, you should try to apply for a fixed rate interest only loan to know for sure that the interest rate will remain the same over the whole life of the loan. Thus, you will be able to avoid variations on your mortgage loan payments that could otherwise lead to defaulting on your loan.
Risk Of Default And Repossession
The problem with the variable monthly payments and the interest only payments for a limited period of time is that though you can have lower monthly payments that are easy to afford, whenever the payments increase, you need to be able to afford the difference or else, you might default on the loan and risk repossession of the property.
Some time ago, lenders required that you show proof of a suitable income or sufficient liquid assets for repaying the loan. Nowadays, by charging a higher interest rate they are willing to risk it and lend the money with a lower income requirement. But what you need to understand is that the one taking the risk is the borrower, because the lender can always repossess the property and force its sell in order to recover his investment and since you will not build any equity, in the event of default, it will be all losses for you.