An Interest Only mortgage is one that only pays off the interest on the loan and doesn’t pay off ANY of the initial loan amount...
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Advantages of Interest Only mortgages
As the Interest Only mortgage does not pay off your loan it may be hard to see what advantage it can have but there are some advantages in particular circumstances. The main point to notice about the Interest Only mortgage is that the monthly payments can be low for a relatively large loan – because you are not paying off the capital at the same time. That can mean that a buyer can borrow more and buy the house they want in the short term while they arrange another method of paying off the main loan.
Short Term Profitability
Sometimes in a short term arrangement the house that a buyer has purchased may have increased in value in a relatively short space of time enabling the purchaser to sell the house, pay off the Interest Only mortgage, and all fees and penalties and still have made a small sum of money, but it should be said that gambling on the hope of strong house price rises is a very risky business indeed.
Interest Only mortgages can serve a short term function to a buyer who knows that there income will increase greatly at a later date when they will be able to afford the increased payments of a standard mortgage. This might include borrowers who are about to pass a qualification of some kind that will allow them to earn more. It may also include borrowers who are certain of a maturing investment of some kind.
If a borrower is very sure that they can invest their mortgage pay-back portion of their monthly repayments in an investment that will give them a much larger profit than the sum of the initial loan they may decide to take an Interest Only mortgage so that they are free to invest the repayment portion as they wish. Again, this can be a risky business but there are some borrowers who feel that they have enough financial expertise to do this.
In short the main advantage of an Interest Only mortgage are the relatively low initial payments that can be achieved against a large mortgage. This can allow a buyer without the necessary current income to buy a home of a size or in an area that they couldn’t otherwise afford. However it can only be a short term solution because the initial loan will still need to be repaid.