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Interest only mortgage loans are a unique lending instrument that is offered in the market. With an interest only mortgage, you only pay the interest on the loan each month. Therefore, your payment is going to be smaller as you are not paying any of the principle of the loan throughout the repayment period. For certain situations, these types of loans can be beneficial. However, they are not always in a borrower's best interest. Here are a few reasons to avoid interest only mortgage loans.
1. Making No Progress
The bad thing about about an interest only mortgage loan is that you never make any progress on the loan. You are making mortgage payments, but you never accumulate any equity. The entire amount of your payment each month just goes towards the interest on the loan. If you are doing this, you might as well be renting a house because you are not gaining anything. With a regular mortgage, part of every payment is going towards the equity. This means that at the end of the mortgage, you will have completely paid off the loan. At the end of an interest only mortgage, you still have to come up with the entire amount of the mortgage.
2. Balloon Payment Danger
Many people never make any plans towards a balloon loan. They think that the future is so far away and they will figure out something before it gets to that point. However, many people who do that are completely blindsided by the balloon payment once it becomes due. Most people can not come up with over $100,000 cash on a whim. This will require that you refinance the loan and you may not be able to on such short notice, or if you can, the terms may not be favorable. Then when you refinance, you have basically started paying for the house again. You just paid the entire amount of interest for one mortgage and you will still be forced to get another mortgage at a later point in time. This can be very frustrating.
3. May Not Sell
Many people get into an interest only mortgage thinking that they will be able to sell the house eventually and not have to worry about it. They think that they can just take advantage of just making interest payments for a while and then sell the property. To them it will not matter if they do not build any equity because they are just planning on living in the property for a short time. Unfortunately this does not always work. Sometimes the property will sit on the market for months or years. If you wait too long to try and sell it, you could reach the balloon payment due date and be in some serious trouble.
If you reach the balloon payment date and the house is still in your possession, you will be forced to come up with all of the money at once. You could face foreclosure or have to do a last minute refinance.
