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Is an Interest-Only Loan Right for You?

Many mortgage brokers today offer interest-only loans where, for a fixed period of time, the borrower's minimum monthly payments consist solely of the interest on the loan. The borrower then has the option to choose how much additional payment they want to apply to the mortgage principal.

After the interest-only period, the borrower is responsible for paying the remaining principal on the loan

Interest-only loans are generally offered as 30 year mortgages where the interest-only period covers the first three, five, seven or ten years of the loan. After the interest-only period, the borrower is responsible for paying the remaining principal on the loan within the original 30 year period.

An interest-only loan may be best for you if you have a variable income, can benefit from investing monthly savings during the interest-only period of the loan or do not plan on living in your home for more than a few years.

Have more control over your monthly payments

Because the principal portion of your monthly mortgage payment is flexible, you have more control over your cash flow. Especially when you are in a situation where your monthly earnings fluctuate, an interest-only mortgage is beneficial because you can afford a higher priced home than you would be able to with a traditional mortgage loan.

The minimum payments would be smaller so they would still be manageable during months when your income is lower. Then you could make up the difference in principal during months when you can afford to make larger payments.

Investing the monthly savings

With an interest-only mortgage loan, you have the option to not pay any of the principal during the interest-only period. The extra spending money you have available can then be used to invest in something that brings a higher rate of return. For example, you could pay down higher interest credit card debts, make home improvements or pay for college tuition.

An interest-only loan is especially ideal if you plan to move out of your home before the interest-only period of your loan is over. If this is what you're planning on doing, you'll be able to reinvest your savings. If you do not intend to live in your home for more than a few years, your money may be better spent on things other than paying down the principal on what is a relatively low interest rate loan.

Gaining equity in your home

Many people think that if you have an interest-only loan and you do not pay anything more than the minimum payment per month, you are basically renting a house because you do not build equity. The truth is that there are many benefits an interest-only loan has over simple renting, including the opportunity to build equity in your home.

Homes in the U.S. have been appreciating at a rate of about 5 percent per year. This means that even if you aren't paying down the principal on your loan, you are gaining equity in your home because you can sell it for more money than the value of your loan. This is especially the case when you apply the money saved in monthly mortgage payments to home improvements that further increase the resale value of your home.

Additionally, an interest-only loan is different from renting because it classifies you as a home owner instead of a renter. This means that while you may be required to pay property tax and purchase property insurance, you'll have many tax advantages afforded to you as a home owner.

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