Just like during the real estate boom, interest-only mortgages are slowly coming back. Interest-only mortgage means that you will only pay the interest that has accrued on your home loan every month. This is contrary to the traditional repayment of property loans; where part of the capital and the interest are repaid together each month so at the end of the month. Interest-only mortgage rates are similar to those of the traditional mortgages; fixed mortgage rates and adjustable rates mortgages (ARM). However, these rates are higher due to several inherent risks that are associated with this type of property loan.
Interest-only mortgages almost disappeared in the year 2008 because many people believed they were the main cause of the inflation experienced in the housing market ahead of the financial crisis. Having such a negative implication, interest-only mortgages might be difficult to sell in the market today. However, it is surprising that interest-only mortgage is the latest magic pill in property financing world. To start with, there is a fierce competition among lenders who are willing to go to any extent to make it easy for you take an interest-only mortgage.
Lenders have introduced deals that allow the borrowers to take an interest-only mortgage with a deposit of 25 per cent, and they pay it off when they sell the property. The second obvious reason for the rising popularity of interest-only mortgages is family economics. Repayments are lowered as the repayment structure the capital borrowed is delayed towards the end of your loan payment. This is when you are required to repay in a lump sum.
Therefore, this popularity of interest-only mortgages may be largely pegged on the reflection that borrowers want to minimize their monthly fixed cash outflows to preserve their lifestyle. Based on borrowing norms, being reluctant to cut back extravagant spending combined with rising housing prices could mean storing your problems for the future hence should be avoided completely. Similar to other traditional mortgages, interest-only mortgages have their shortcomings and advantages. Therefore, we need to get the right information that can help us make appropriate decisions and avoid some of the pitfalls associated with the interest-only mortgages.
There is no home equity. You cannot build wealth without home equity. During the first few years, payments are on interest only. Therefore, the borrower depends on the appreciation of the property to create wealth. The interest-only mortgage also attracts a higher interest rate. Due to a high rate of defaults on payments, mortgage lenders understand the risks on interest-only mortgages. To be able to absorb the potential losses, interest-only mortgage rates are higher.
Adjustable-rate mortgage with interest-only mortgages can also lead to a worst case scenario if the rates go up. The mortgage lenders will charge you with the current interest rates, but in case the interests increases, the burden falls to you, and you may not be able to pay the monthly mortgage payments.
Unsuspecting borrowers can also be deceived by the affordability of interest-only mortgage. Paying less may encourage you to buy a new home or desire to acquire a more expensive home. The reality bites in case the home market values decrease, interest-only mortgages rates rises or when the time to repay comes.
A wise borrower should be aware that nothing last forever. Mortgage lenders are expecting you to repay after interest-only mortgage term. This period takes a maximum of ten years, and then you convert to the conventional way of paying the mortgage. Home market values may also decline posing a potential loss to the buyer. This should be a caution to investors who take interest-only mortgages with an expectation that market values will rise and sell at a profit.
Why are interest-only mortgages attractive? Despite the many shortcomings, these mortgages will allow you to buy a larger and a more expensive home in a better neighborhood. Properties are affordable therefore many people are willing to take these contracts. Also from a real estate agent’s perspective, the interest-only mortgage will allow you to sell more homes because many people can afford. Furthermore, the agent will make fatter commissions on the expensive loans.
Generally, despite the fact that interest-only mortgages are perfect when home market values are on the rise, a buyer should not ignore the risks associated with the interest-only mortgages. Knowledge of the risks will help you determine the perfect time to boot out.