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An interest only mortgage means lower payments--at first.

Tim Worstall
LoanBiz Columnist

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With a traditional mortgage, your payments are applied first to the interest on your balance, then to the principle balance on the loan. "Amortize" is just the technical word for paying off the principle. The difference between a regular home loan and an interest only mortgage is that with the latter you are not required to pay down the principal during the first few years. You only have to pay the monthly interest charges. This may enable you to afford a better home.

If I don't pay down the home loan, what's the value of an interest only mortgage?

If you are not making that fully-amortized payment each month, your monthly home loan payments are lower with an interest only mortgage. This means that you may be able to spend more money on the house itself, perhaps a larger house in a better neighborhood, and still live within your means. The chief benefit is that you can skip the "starter" home and save the cost of buying, selling, and moving.

However at some point, that loan must be repaid and the payments will increase--perhaps dramatically. Typically borrowers avoid this by selling or refinancing once the house accrues some equity. You could also begin paying down the principle in the future when you are earning more money.

An interest only mortgage is not a magic bullet. It doesn’t mean you do not have to pay back the home loan. It just means that you will have more affordable monthly payments initially.


About the Author
Tim Worstall has a degree in finance and accountancy and writes extensively on matters economic and financial.

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