Clear Talk About Mortgages

Should You Choose a Sub Prime Interest-Only Mortgage?

If trying to afford a new home in an overpriced housing market, you may be tempted to choose an interest-only mortgage loan. These loans have become very popular in recent years. Similar to traditional mortgage loans, interest only loans feature a set loan term, and borrowers may select a fixed rate or adjustable rate mortgage. The primary difference with interest only loans is that borrowers do not make payments toward the principle throughout the initial two to five years in a sub prime market. Select Fannie Mae products in the prime market allow a ten to fifteen year interest only period.

Borrowers Expect Payment Increase

Throughout the interest only period, borrowers can take advantage of temporarily low payments. Once the interest only period ends, the mortgage payments are fully amortized, wherein borrowers must start paying both the principle balance and interest. Because many people do not make extra payments toward the principle during the interest only period, the loan balance never decreases. Everyone who considers an interest only mortgage loan must take into account payment increases that will occur once the interest only period is over. Can You Afford an Interest Only Payment?

Borrowers have to realistically look at their situation and determine whether they can afford future payment increases. Don't let a mortgage broker persuade you to buy a home you might not be able to afford. Assess your spending habits and take into consideration your current expenses and debt load. Some borrowers choose 100% interest only financing, which can be very dangerous. If the asking price of real estate decreases, and your property's value declines, you won’t be able to sell the home, or you'll sell it for less than you paid. On the other hand, if you are fully confident in your ability to handle a higher payment in the future, an interest only mortgage loan may be the ideal choice for you. Enjoy Reduced Monthly Payments

The number one reason why interest only loans are so popular is because they feature lower monthly payments in the beginning. Homebuyers may be able to purchase a more expensive or larger home, and individuals with a high debt-to-income ratio can qualify for pricier residences. Today, it is much harder for first time buyers to find affordable properties. Interest only home loans can help you realize the dream of homeownership. Plus, if home values continue to appreciate, you'll gain equity in your property before principle payments begin. Fixed Rate vs. ARM

You can choose an interest only mortgage with a fixed rate or adjustable rate. The safe choice would be to select a fixed rate loan because you won’t have to worry about future rate adjustments. Borrowers who opt for an interest only loan have to prepare for a payment increase. An adjustable rate interest only loan creates an additional headache because borrowers can’t predict their interest rate at the end of the interest only period. With a fixed rate loan, you'll at least be able to estimate monthly payments. Unfortunately, there is no way to foresee whether mortgage rates will rise or fall, which makes adjustable interest only loans very dangerous. For example, an interest-only mortgage on a 3/27 means your rate will adjust after three years, and the loan may become fully amortized at a much higher rate. In a worse case scenario, your monthly mortgage payment with an ARM will increase tremendously. Is a Sub Prime Interest Only Loan a Good Choice?

The question remains, is a sub-prime interest only mortgage a good choice? This depends on several factors. If you plan to buy in an area where home values are steadily increasing, an interest only loan might mean building equity without reducing the principle balance. Additionally, the monthly savings with an interest only mortgage loan can be used to start a savings account or reduce unnecessary debts, which can help you prepare for future payment increases.