How Interest Rate Only Mortgages Work – pret hypothecaire

When you send in your monthly mortgage payment, part of it goes to pay the lender its interest, and part of it goes to pay down the loan. That’s the way a normal mortgage should work. Banks have now come up with a new type of mortgage called interest only. This means that if you pick an interest only option, each month you pay your mortgage, the loan balance stays just the same; it never goes down. Even with more conventional home loans, you could pay extra on your mortgage to reduce the principal balance faster, but the idea here is to keep the monthly payment low. There may have been some reason for this type of loan when home prices were increasing drastically, since the homeowner would be guaranteed some equity due to the increased home price. Normally, equity in a home is gained by a combination of paying off the principal and rising home values. But the housing market now does not mean that you will earn equity in your home just by market increases. The only reason that one would prefer to have an interest only loan is to keep the monthly payment as low as possible. This might be valid option if it were a temporary situation. Suppose, for example, that a couple bought a house at the time when one of them was working and one of them was still studying. This is a temporary situation, and as soon as the second partner finishes his studies and starts a job, the loan should be switched to interest plus equity or additional payments should be made to reduce the loan. Or perhaps a home owner has a sporadic type of income, in that he earns very little for a while and then receives a large payment. Perhaps someone who worked on large projects and was only paid at the completion of them might have such a pattern. Keeping the mortgage low in the months when income was low and then paying additional equity when the windfall came would be a sensible decision, as long as the discipline was there to make the additional payments. But in any of these cases, the homeowners cannot count on the value of the home rising and should make sure principal payments are made. Using a traditional loan mechanism, if the home value is lower, flat or only goes up slightly, the margin of equity that the homeowner deposited will cover the difference. If no equity has been paid down, the owner will have to raise additional cash to pay off the mortgage if home values have not sufficiently increased.

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