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Interest Only Mortgages

May 3, 2008
If you're in the process of buying a house, you may have come across the phrase "interest only mortgage". As the name suggests, this is where you simply pay the interest and nothing else for the duration of the mortgage. There are pluses and benefits to these types of mortgage, and as long as you're aware of them, and can afford to take it out, then an interest only mortgage may offer you a workable solution to affording your first home.

The Pros

Perhaps the most obvious part of an interest only mortgage is that because you're only paying the interest on your house, the payments are a lot lower than what they would be on a more traditional mortgage. Since the interest on a mortgage is only a small percentage of the overall cost, then that shows in the monthly payments. This allows you to be able to have more "free money" each month, which of you're just starting out on the property ladder can make all the difference.

An interest only mortgage also allows you to make better use of that extra money. For example, you could put it into a high yield savings account, or stocks, or even another property, which you could then rent out. This would then see you having residual income every month, which you could then transfer to your high interest savings account to pay for your mortgage at the end of the loan period.

The Disadvantages

Although an interest only mortgage offers many advantages over a more traditional mortgage, there are also the downsides to it that you should be aware of before you sign up for one.

Ironically enough, the big advantage of this type of mortgage is also one of its biggest disadvantages. Because you're only paying the interest on the loan itself off, you're not taking anything off the principle sum, or the mortgage itself. Therefore, when the end of the mortgage period comes round, you're going to have a substantial amount still to pay. Unless you've saved for that time, you could find yourself coming up short and losing your home, even if it's 25 years down the line.

If you decide that you do want to take out an interest only mortgage, there are ways that you can help yourself prepare for the end of the repayment term. These include:

Paying into a monthly savings or investment account
Sell another property (if applicable) or use any inheritance you may have
Switch to a repayment mortgage throughout the duration of the interest only one. This is especially popular with people who find themselves promoted to a higher paid job, for instance
Sell the actual property to pay for the loan

These methods all have their pluses and minuses, and some are more attractive than others. This is why it's important for you to be completely sure that you understand what's involved with interest only mortgages, and whether they're right for you, before signing up for one.
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