Interest only FHA mortgages have become more popular for people who expect their future earnings to increase. An interest only loan is a mortgage where you pay only the monthly interest on the loan for a set period of time. During this time your payments are lower because you have not begun to pay back the principal on the loan yet.
Interest only loans have some positive and negative aspects which include:
- Interest only loans can create negative amortization. Amortization is the payment schedule by which you slowly pay off your principle loan over a set period of time. Negative amortization occurs when the principal balance on the loan increases instead of decreasing. This can occur if interest rates rise above your payment cap so the lender adds the unpaid interest to your original loan, and since you are not paying any of the principal with an interest only mortgage your principal balance actually increases over time./li>
- Interest only loans are great for people who expect a rise in pay. If you found the home you want, but the payments would be a little too high right now, but you are up for a promotion soon, then you can purchase the home with an interest only loan so you can have lower payments now and higher payments after you are making more money.
- You are not paying off your loan with an interest only mortgage. None of the original loan amount is being paid, and if for any reason you need to sell the home then you will have built no equity from owning the home unless the real estate prices have inflated in your area.
- The payments may not be affordable after the interest only period. Make sure that your interest only period is long enough for you to be making more money so that you can manage the new higher monthly mortgage payments into your budget.
- You may need to incur the costs of refinancing. After the interest only period most interest only mortgages become adjustable rate mortgages and you interest rates will rise. So it makes sense to refinance into a lower fixed interest rate if you are planning to live in the home for a long period of time.
Interest only loans can be a great choice if you are not planning to live in the home for more than the interest only period, if you are expecting a pay raise in the future, or if you are trying to resolve some credit issues so that you can refinance into a lower fixed rate loan. Before you choose an interest only loan make sure you know what the payments will go up to after your initial interest only period, and be certain you can afford the new monthly payment.