October 26, 2007, Newsletter Issue #153: Interest Only Mortgages

Tip of the Week

As interest rates have begun to rise and home prices remain high in many areas, some lenders are offering interest only mortgages. As the name suggests, you pay interest only on the loan, so the principal amount is never reduced. Some interest only loans add in a principal payment after the first few years. The risk here to the borrower is obvious: you aren't building any equity. If you pay only interest for five years, you still owe the bank the entire mortgaged amount at the end of five years. These loans are often used to qualify people for a more expensive house than they could otherwise afford. While they may be able to pay the interest for the first five years, they cannot afford the higher payment once the principal is added in. An interest only loan is only appropriate in very specific circumstances - if you know your income will significantly increase in a certain number of years, if you will have an influx of money at a certain time, or if you plan to only own the house for a short time, for example. Be very wary of the interest only loan.

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