Interest-only mortgages are a relatively new phenomenon in the re-financing industry as well as the home buying industry. While the appeal of an interest-only mortgage is typically a greater monthly cash flow, this increased cash flow can come with a hefty price tag. In exchange for more cash flow each month, the homeowner may be sacrificing the ability to obtain a fixed-rate mortgage as well as the ability to build equity. This article will further examine these features to provide the reader with more information on the subject of interest-only mortgages.
Greater Monthly Cash Flow
The one main advantage for many homeowners in an interest-only mortgage is the ability to increase monthly cash flow. Homeowners who re-finance by utilizing an interest-only mortgage will likely have more money available each month because they will only be paying interest on their mortgage initially. The reduction of the principal payment can make it easier for the homeowner to either afford a larger house or have the ability to live more extravagantly on their budget. However, there is often a significant price to pay for these types of re-financing options.
While interest-only loans may not be ideal, they can be beneficial in the situation where the homeowner is having a great deal fulfilling his monthly obligations. In this case, the homeowner may be willing to sacrifice an overall financial loss for the ability to continue to pay monthly bills in a timely fashion.
Unknown Risks of an ARM
Interest-only re-finance loans are typically offered with an adjustable-rate mortgage (ARM) this means the interest rate is not fixed and may fluctuate with the rise and fall of the prime index. This risk can be quite costly for the homeowner if the interest rate rises significantly. There is usually a cap placed on the amount, in terms of percentage, the interest rate can rise in a certain period but this can still be a very costly mistake for the homeowners.
An ARM re-finance option with an interest-only component may be worthwhile in some situations. For example, if the homeowner has a hybrid mortgage that features a fixed interest rate during the interest-only portion and an ARM during the principal and interest portion of the loan they might benefit from this situation if they do not plan to stay in the home for longer than the interest-only period. This period may vary depending on the lender and the circumstances. Homeowners who plan to sell the house before the interest-only period ends and the ARM period begin to enjoy the benefits of lower monthly payments and the security of fixed interest rates before they ever have to worry about repaying the principal or dealing with the varying interest rates.
No Equity in the Home
Another disadvantage to the interest-only re-finance loans is they do not allow the homeowner to build equity in the home during the initial period where only the interest on the loan is repaid. This can be a problem for homeowners who are looking to profit through the sale of their homes. These homeowners may find the participation in an interest-only re-finance has had a damaging effect on the profit they are able to generate from the resale of their home.