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Interest Only Mortgage  

Two different types of mortgages you have probably heard something about are the fixed rate mortgage and the adjustable rate mortgage.  There is a third type of mortgage you may not know as much about.  It is the interest only mortgage.  As the name implies, this is a mortgage where you are only paying the interest on the loan, and not the principal.  You may wonder when and why this type of mortgage is a good fit. 

If you have a second mortgage in the form of a HELOC (home equity line of credit), or if you have an ARM (adjustable rate mortgage) or have done mortgage refinancing, part of your loan may be an interest only mortgage.  With an interest only mortgage, you only have to pay the interest each month in your mortgage payment.  For a specified period of time, this keeps your monthly payment quite a bit lower than it would otherwise be with the principal added in also.  After that period of time is over, the loan must be paid in full, may require some type of balloon payment, or may be adjusted to a higher monthly payment in which you pay both interest and principal.  For instance, you may have a 30 year second mortgage where the first ten years are interest only, and the last 20 years are fully amortized with both interest and principal.  Interest only mortgages may be obtained with a variety of terms, such as 10 or 15 years, but you may find some that only last for 5 years before the mortgage is due in full or you will need to refinance the home. 

You may wonder why anyone would want to simply pay interest on the loan rather than also paying toward the principal of the home so that they could build equity.  This type of loan or mortgage refinance works for people who know they will have more money in a few years, but need a loan now.  An individual with bad credit may also not qualify now for a regular amortized loan, but can qualify for an interest only loan.  During the interest only time period, they can improve their credit score then refinance at the time when the loan amount or balloon is due.   

In the past, interest only loans were primarily used for bad credit mortgages, but now are often used for second mortgages.  This type of mortgage can be risky because many people find that when the interest only period of time is up, they don’t have the money to pay the balloon payment, or they can’t qualify for mortgage refinancing so they lose their homes.  With interest only mortgages used as a second mortgage, it seems to be more likely that the homeowner can pay the money when due, or qualify for refinancing and make it a successful situation for lender and borrower.