Interest-only Mortgages Have their Pitfalls

Interest-only Mortgages Have their Pitfalls

Recent increase in home prices has brought home ownership beyond affordability of many American families. Nevertheless, currently more Americans own their homes than ever. This is encouraged by the great number of home loan programs available on the market nowadays.

One of them is increasingly popular interest-only mortgage. With this type of mortgage loan a home owner pays no principal for a certain period of time, usually from one to five years. After this particular period the principal is added to monthly payments, so they become higher. This potentially allows a buyer to afford a more expensive house than he actually would be able to with another type of mortgage. It is expected that buyer’s income will increase in time so he will be able to make those higher payments.

The main disadvantage of the interest-only mortgage is that equity doesn’t occur in the home if the principal is not added to monthly payments. If home equity is the only large financial asset that you can possibly have, it might be not a good idea for you to apply for this type of loan. For many people equity is a sort of emergency capital, too.

Equity can be built in two ways: either by paying the principal down or by an increase in your home’s market value. So since home prices are constantly growing, many customers don’t mind paying only interest for several years. But what if prices fall?

Another problem with interest-only mortgages is that their interest rate can vary. So if interest rates rise, monthly payments will increase. If after increase a home owner won’t be able to afford his monthly payments, he will be forced to sell his house. Now, this could lead to a glut in the housing market, causing prices to fall. Owners wishing to sell could find that they owe more money than their home is worth and that they have no equity.

So, even though interest-only mortgage loan can help you to afford a house that otherwise you might not, you should think carefully, whether to apply for this mortgage loan type or to search for another one that may be more appropriate for your situation.

© 2010, Jericho Mortgage — Interest-only Mortgages Have their Pitfalls