- The monthly payment of an interest only mortgage covers only the interest that accrues on your mortgage for a specified period, typically five to 10 years. During this time, you do not pay off any of the principal that you borrowed. After the introductory period, the mortgage shifts to an amortizing mortgage for the remainder of the term. When the payments shift, the size of the monthly payment may even double or triple, according to the Federal Reserve.
- Interest only mortgages have adjustable interest rates that will change with the prevailing market rates over the life of the loan. The rate typically remains fixed for an introductory period of one to five years and then adjusts annually thereafter. The Federal Reserve warns borrowers to be wary of low initial interest rates that last only a few months. After the teaser rate, the rate will go up to market rates.
- Interest only mortgages benefit people who either have variable incomes, are paid in large bonuses at the end of the year or expect to earn significantly more in the coming years. For example, if you have a significant chunk of your income coming from year-end bonuses, an interest only mortgage can offer you the flexibility of making smaller, interest only payments during the year and then a large principal payment when you get your year-end bonus. Also, if you expect to be making a lot more in the next few years, your budget will be able to handle the increase in payments when you have to start paying off the principal as well.
- The Federal Reserve warns that you should not use an interest only mortgage as an excuse to borrow more money than you can afford if you are not certain your income will increase in the next few years. Also, if you plan to take out an interest only mortgage and invest the money that you save on your mortgage payment, make sure you actually invest the money because it is very easy to spend the extra and not put aside money for when your payments will increase.
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