Today, we will discuss interest-only mortgages, the way in which they work, as well as the risks and benefits associated with making this financial decision.
To start with, when it comes to an interest-only mortgage, the repayments will cover the interest on the sum of money you’ve borrowed solely, during the interest-only timeframe. This type of loan could be a viable option if you’re considering getting a house or refinancing your existing mortgage.
Nonetheless, although it may seem like an adequate choice, you should still get acquainted with the risks and benefits.
Introducing Interest-Only Loans
For the most part, the majority of home loans are principal-and-interest loans. In other words, your repayments will minimise the amount you borrowed, aka the principal, while paying off the interest, as well.
Still, if you take on an interest-only loan, you’ll pay interest only on a previously agreed timeframe, which is usually up to five years. When that timeframe expires, the loan will imminently return to a principal and interest loan, meaning that you’ll repay both the interest and the principal from that point onward.
On that note, before taking out such a loan, you should determine if you can cope with the increased payments.
Interest-Only Loans Risks
While interest-only loans appear to be more affordable, they might cost you more, in the long run.
Simply put, during the interest-only timeframe, you won’t diminish the sum of money you owe. That translates into paying more money on interest over the lifespan of the loan. For instance, in the case of a 25-year loan worth $500,000, with a 5 percent interest rate, you will pay $40,062 more interest, in comparison with a typical loan.
That’s because as soon as the interest-only period comes to an end, you must start making repayments for both interest and principal. Nevertheless, you’ll have less time, meaning that the repayments will have to be larger.
Concurrently, if the value of your property doesn’t increase during the interest-only period, you won’t build equity in your home, although you have made repayments on a monthly basis. That being said, having no equity in your home places you in a risky situation in the event in which you might be required to sell the house.
Interest-Only Loans Benefits
While these types of loans are associated with a bunch of risks, there are also benefits worth considering.
For starters, in the event in which you have the possibility of making extra repayments during the interest-only period, this could only mean good things. You might direct the money you save from making lower repayments to pay for high interest loans such as personal loans, credit cards, so on and so forth.
What we’re trying to say is that interest-only loans can work for you; it all depends on your current financial situation. What is more, another potential benefit is that interest-only loans allow you to maximise your tax benefits.
To sum up, each financial decision you might make has its potential pros and cons. That’s why you should take the time to analyse your situation and determine what would work best for you: an interest-only loan or another type of loan.