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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Disadvantages of Interest Only mortgages
It’s not difficult to see what the disadvantages are of a mortgage arrangement that doesn’t provide you with any money at the end of the term to pay off the loan and therefore doesn’t buy the home that you live in. The Interest Only mortgage is not far removed from a form of rent. While it’s true that the home can be sold at the end of the term this still leaves the home owner reliant on a buoyant housing market to make any money and at the same time with nowhere to live.
Separate financing to pay off the loan can be risky if the investment doesn’t perform the way it was first predicted to do so – and we all know how unpredictable the financial markets are. There are plenty of borrowers who thought their endowment policy wouldn’t leave them with a short fall who can testify to that fact. A standard repayment mortgage that slowly pays off the loan as well as the interest is guaranteed to leave you living in a house that you own by the end – even if the monthly payments are higher it is a valuable pay-back.
The greatest danger of an Interest Only mortgage is to those who have not fully understood what they have signed up to. Although it is hard to believe that anyone could make such an important decision without looking at the consequences there are many borrowers and co-borrowers who have a ‘head-in-the-sand’ attitude towards finance which could be disastrous in the long run. As with all important mortgage decisions it is a good idea to get approved advice and if you are entering into a complex separate financing deal it is essential that you have fully appreciated the outcome of changing circumstances.
Another disadvantage to Interest Only mortgages is that because initial monthly payments are low it can lead borrowers to borrow more than they will be able to manage if they later switch to a standard repayment mortgage. An anticipated increase in income may not cover the higher monthly payments if the income rise is slightly less than expected or in the meantime interest rates have risen.