Interest Only Mortgage
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Interest only mortgage explained:
An interest-only mortgage is a type of home loan where the borrower is only required to pay the interest on the loan for a certain period, rather than paying both interest and the principal (the actual loan amount). After the interest-only period ends, the borrower must start repaying both the principal and the interest.
Initial Interest-Only Period:
- Typically lasts between 5 to 10 years, during which you only pay the interest on the mortgage.
- Your monthly payments are lower because you’re not repaying the loan principal during this time.
Repayment of Principal After Interest-Only Period:
- Once the interest-only period ends, you must start repaying both the principal and interest, which can result in much higher monthly payments.
- Alternatively, some borrowers may choose to repay the entire loan balance by selling the property, using savings, or refinancing the loan.
Advantages:
- Lower initial payments: The interest-only structure results in reduced monthly costs, freeing up cash for other investments or expenses.
- Flexibility: It allows borrowers to potentially invest or save the difference in lower payments elsewhere.
Disadvantages:
- Increased future payments: When the interest-only period ends, monthly payments can spike significantly as you begin to repay the principal.
- No equity buildup: During the interest-only period, you are not reducing the amount owed, which means you aren’t building equity in your property.
- Higher overall cost: In the long run, you may end up paying more in interest because the principal remains unchanged during the interest-only period.
Risks:
- Negative equity: If property values drop and you haven’t paid down any of the loan principal, you may owe more than the property is worth.
- Payment shock: The jump in monthly payments when the interest-only period ends can be difficult to manage for some borrowers.
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