An interest only mortgage is a mortgage upon which you pay only the interest (as opposed to paying the interest and principal under a traditional mortgage) in monthly payments for a set amount of time. Sometimes, the set time period is one year, three years, five years, or some other time period as agreed upon between yourself and the lending institution. At the end of the time period, the entire balance of your mortgage becomes due (meaning that if you have a mortgage for $100,000 and the mortgage is interest only, at the end of the interest only period, you owe $100,000 in one lump payment), and thus, you have to pay the entire balance of the mortgage in one lump sum payment. Usually, before the interest only time period expires, the mortgagor will refinance the mortgage with the lending institution from which he/she obtained the interest only mortgage or will refinance with some other lending institution.

An interest only mortgage is attractive to many people because the payment on an interest only mortgage is less than the payment on a traditional mortgage. The interest only payment is less because that payment does not factor in any principal into the payment amount. Additionally, because the principal balance on your mortgage barely decreases during the first five years of the life of your mortgage (based on a traditional 30 year, fixed interest rate mortgage), many people would rather use the saved money for other purposes.

An interest only mortgage does have some advantages and some disadvantages. In regard to investment purposes, an interest only mortgage can help create a positive cash flow because, as stated above, the mortgage payment on an interest only payment is less than the mortgage payment on a traditional mortgage. However, because of the shortened time frame of the loan, you have to be very careful about the purchase price. If you buy a house for an inflated price during a real estate boom and take out a mortgage for that amount, that is that loan amount that you are stuck with. Therefore, if the real estate market decreases, and, as a result, your investment property decreases in value, you will not be able to refinance your loan for the original loan amount. Thus, you are going to lose money, or, in the worst case scenario, you are going to lose the investment property.

In regard to residential purposes, I am not a fan on interest only mortgages. In my opinion, gambling in the real estate market with your primary residence is a risk not worth taking. The point is, regardless on your ability to analyze and predict the trends of the real estate market, sometimes your current life situation does not allow you the freedom to sell your home. Therefore, you may be stuck with an overpriced mortgage in a declining market.

Whatever your decision, make sure you carefully analyze your situation and determine whether or not an interest only mortgage is the correct decision. Take into consideration the type of property upon which you are taking the interest only mortgage. If you are careful and factor in contingencies, your decision should be sound.

Learn more about this author, Marco Angioni II.
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