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Pros and cons of interest-only mortgages

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Homebuyers who feel blinded by rising funding costs want to explore an unconventional mortgage called an interest-only mortgage with far less initial payments than a standard mortgage. May be.

However, these loans have some major drawbacks that potential borrowers should also be aware of.

For interest-only mortgages, you initially pay only the interest on the loan. Usually the first 5 or 10 years. The advantage is that these initial payments are cheaper because you are not obliged to pay for the total amount of borrowing called principal.

After the first interest-only period ends, you will begin paying the principal and interest for the rest of the loan period. Payment terms vary, but interest rates are usually reset to the current prevailing interest rate. This may be rising. And once the principal is included, these payments can cost twice or three times the amount originally paid on the loan. According to the Federal Deposit Insurance Corporation..

If the payment is too high, the borrower can try longer negotiations or, if possible, refinance the loan at a lower mortgage rate.However, it is still about refinancing 2% to 5% Of the total loan amount, it is possible to offset the savings from the reduction of monthly insurance premiums.

Interest-only mortgages are now “growing in popularity,” said Shmuel Shayowitz, president of the mortgage company Approved Funding. For some homebuyers, he says, “it helps fill the gap with monthly payments.”

But, again, as Shayowitz points out, these types of loans have drawbacks that all borrowers should consider, even if they can temporarily save hundreds of dollars a month.

Disadvantages of interest-only mortgages

First, these loans usually charge higher interest rates than traditional mortgages. The reduction in monthly costs will only occur if you start paying the principal at a later date.

It also pays higher interest rates and pays more interest as a whole, so you will pay more interest over time compared to traditional loans.

There is also the risk that mortgage rates will rise over time, as they have recently. This will result in higher monthly payments than originally expected after the interest-only period ends. The burden of these additional costs may put the borrower at risk of default on the loan.

Increased rate hikes are normal The upper limit is about 2% After the first interest-only period has expired, it can still be quite expensive.

Another risk is that if your home loses value, later selling the property may not cover the total cost of the loan.

“Think about why you’re considering it,” says Shayowitz. Bad candidates for interest-only loans are those who are looking to “shave off a few dollars” of their monthly expenses just to get into a house that might otherwise not qualify.

Suitable candidates for this type of loan usually have a reliable source of income with sufficient cash flow to cover mortgage payments after the interest-only period has expired. Mortgage rates can still rise, but buyers are willing to accept the risk, especially if they plan to sell their home within a few years. Choosing an interest-only mortgage temporarily frees you cash for other expenses and investments.

“Most of this comes down to putting pens on paper,” says Andy Darkins, a certified financial planner for wealth management firm Vista Capital Partners. He advises potential buyers to perform a “stress test” of short-term and long-term cash flow before considering interest-only loans.

“Look at the different scenarios,” he says. “lastly [interest-only] What if my payment doubles during the period? And what if it falls somewhere between it and your first payment? Ask yourself if you can actually afford to pay in each situation. “

For homeowners who want to minimize their monthly costs, another option to consider is traditional. Floating rate mortgage, Usually offer lower interest rates compared to fixed rate mortgages. Again, with a variety of conditions, adjustable mortgage rates are usually fixed for the first 5, 7, or 10 years and then reset annually or monthly.

The advantage of a floating rate mortgage is that, unlike an interest-only loan, you actually start repayment of the loan immediately and build a building. Home equity that can be rented later, as needed. And you don’t have to pay thousands of dollars of unnecessary interest.

However, floating rate mortgages still carry risks, as interest rates on mortgages can rise. As a result, homebuyers often stick to the certainty of the costs offered by fixed rate mortgages, even though interest rates on this type of loan tend to be higher.

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