Interest Only Mortgage

An Interest Only mortgage is one in which the borrower pays only interest for a set term. At the end of this term, typically five to ten years, the loan converts to a fully amortizing loan in which both interest and principal are paid. An interest-only loan reduces loan payments in the early years of a loan, so borrowers who expect their income will grow over the loan term can take out a larger mortgage for purchase of a home.

Interest-only mortgages are beneficial for first-time home buyers. Many new home owners struggle during the first year of ownership because they are not accustomed to paying mortgage payments, which are generally higher than rental payments.

An interest-only mortgage does not require that the home owner pay an interest-only payment. What it does do is give the borrower the OPTION to pay a lower payment during the early years of the loan. If a home owner faces an unexpected bill -- say, the water heater needs to be replaced -- that could cost the owner $500 or more. By exercising the option that month to pay a lower payment, that option can help to balance the home owner's budget.

Buyers whose income fluctuate because of earning commissions, for example, instead of a flat salary, also benefit from an interest-only mortgage option. These borrowers often pay interest-only payments during slim months and pay extra toward the principal when bonuses or commissions are received.