Interest only mortgage definition
An interest only mortgage is a home loan in which you pay only the interest on the principal balance for a fixed term, usually between 5 and 7 years. As the borrower, you pay interest on the mortgage each month while the principal balance remains unchanged. When the term is over you can refinance your home, begin paying off the principal, or make a lump sum payment in order to pay off the mortgage faster.
Most people hear of fixed-rate mortgages and, probably, adjustable rate mortgages, but there is actually another type of mortgage that is an 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 well wonder why or when this might be a good kind of mortgage.
Interest only mortgage qualification
If you have an ARM or have done mortgage refinancing with a HELOC (Home Equity Line Of Credit) or even a second mortgage, part of your loan may be an interest only mortgage. What this means that for a period of time your monthly payments are quite low because you are only paying the interest on the loan.
After that period of time is over, the loan must be paid in full 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. You may also have a 10 year second mortgage that is interest only.
You may find these mortgages with a variety of lengths, 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 the available funds in a few years, but need the money now. They may do a refinance and get cash out on the loan to use for something that is needed, with a look to the future when other assets should be paying out enough to pay off the total before the end of the loan term.
Several years ago, these mortgages were used as bad credit mortgages, but now you mostly find them as a second mortgage product. When this was an available option, many people found they could not pay back the first mortgage when interest only mortgage term ran out and lost their homes. With interest only mortgages being used as a second mortgage product, less money is being loaned in this way and it is more likely that a person could pay it back when the time comes.