what are the pitfalls of interest only mortgages? Is it financially pretty close to renting?

Answer 1

For starters, think about it! You are not paying any of the principal off. You're simply paying interest. I would avoid this mortgage at all costs. It's NOT a good idea.

Answer 2

The major pitfall of an I/O Mortgage is you don't pay any principal.

Reasons for choosing an interest only loan:

1. Investment purposes. You plan on renovating a home, thereby increasing its value, without making principal payments.
2. You have a variable income and need to have a minimum payment that may be smaller than a traditional principal and interest payment.
3. You feel that you may be able to make principal payments from time to time.
4. You expect an increase in your salary at some time in the future but would like to purchase a home now.
5. And of course, the tax advantages of owning your own home.
If you pay $12,000/year in rent, the money is gone. If you pay $12,000 in interest payments for your home then that is more than likely a deduction on your income tax. Please talk to your tax advisor to confirm any tax benefits.

The Interest only loan is not the monster it seems. First of all, your interest is fixed for a certain amount of time, even as long as 10 years. Your note will more than likely have certain protections for you as a borrower. The first is a rate cap for each change of interest rate. The second is a lifetime cap. For instance if you start out with a rate of 5% then when your Interest rate changes, if it goes up, it won't be any more than 7% but during the entire life of the loan, your interest rate will never be more than 11%.

Also, if you are concerned about not making principal payments, then simply send extra with your mortgage payment. The good news: YOU decide how much principal sent in. WWW.bankrate.com has excellent, easy to use calculators to help you figure out each scenario. I often use it for amortization schedules. If you have Quicken, they also have those "what if " calculators.

If you are financially disciplined, an Interest Only loan can be a powerful tool to manage your monthly expenses.

Hope this helps!

Answer 3

The primary pitfall is that you never reduce your debt. The difference in payments between an interest-only mortgage and a standard repayment mortgage is smaller than you might think. The actual principal portion of a mortgage payment is very small in the early years -- as little as $25.00 to $50.00 depending upon the size of the mortgage.

Also keep in mind that most interest-only mortgages are adjustable rate with a limited lock-in period, typically 2 - 5 years. Once that lock period expires, the rate is adjusted to market rates and principal payments are also required. If mortgage rates head much higher, people with low interest-only payments may see their mortgage payments double or triple once the rate lock falls off!

In many parts of the country, buying is actually cheaper than renting! My mortgage payment on my 3,000 square foot, 5-bedroom home is only $605.00 per month, but the rental market in this area is such that I could rent it out for nearly $1,500.00 per month!

Interest-only mortgages can be beneficial when housing values are rising rapidly and the purchase price is high enough to make a meaningful difference between interest-only and standard mortgage products AND you will be selling the property before the rate lock expires.

The heyday of sprialing housing prices has already come to a close in some parts of the counrty. The bubble hasn't burst just yet but it almost certainly will in some high-cost areas. You could find yourself in a situation where the value of you home has dropped significantly yet your mortgage payment is about to take a breathtaking upwards track AND the outstanding debt hasn't dropped a penny.

IMHO, interest-only mortgages are very risky today and are only appropriate for the seasoned speculator who can afford to cover a loss and needs to maximize cash flow in the present.

Answer 4

An IO mortgage is radically different from renting.

With a lease, your financial obligation is limited to the term of the lease.

With a mortgage, it is for the term of the mortgage and for full amount borrowed.

With a lease, you can walk away in a year (or whatever term of the lease runs). With a mortgage ... no walking away.

the plus side:
(1) you gain the tax advantages of home ownership (ie, deductability of your mortgage interest payments).

the minus side:
(1) you take on all the financial risks of home ownership (including possible depreciation in market value, repair costs, and general upkeep expenses)
(2) since you are making no principal payments, you are accumulating no equity ... if you sell in the future, you still owe 100% of what you borrowed

Answer 5

As long as you get a 5 -7 year arm (adjustable rate mortgage) and there is no prepayment penalty, you can pay your principle down faster than a fixed rate.
On a 30 year fixed rate mortgage on $200,000, your payment would be around $1400 per month, of which you would be paying about $100 on principal and $1300 interest,
On an interest only loan, your payment would be about $1100.
If you added $200.00 to your $1100 payment, your total payment would be $1300, so, your paying a $100 more per month on your principle than on a fixed rate and your saving $100 per month on your payment.
With a 5-7 arm, you will always refinance during an election year.
Election years are the lowest rates for refinancing. Since your paying additional principal, your refinance will always be for less money, which will reduce your monthly payment further.
Renting gets you zero write off on your taxes.
You get to write off 100% of your interest payment. If you pay $12,000 per year on interest, you will get back around 30% ($3,600) back on your tax return, so amortized out, you are actually paying $740.00 per month for your home.
You are also getting the appreciation value. Depending on your area, appreciation should be at least 3% or higher, so, your making an additional $6,000+ per year.
Buying beats renting at every turn.

Answer 6

Major pitfall is that it is a riskier loan for the bank, so they charge a higher interest rate. Even if the payment is lower, none of it goes to pay down the loan.

You also get the effects of price fluctuations, good or bad. Your property you bought for $400,000 becomes worth $500,000, that's $100,000 you made (less the cost of selling). If it drops in value to $300,000, that's money you owe or money you've lost. You owe the bank their money. You owe the bank every penny of their money. It's what's left over after everything is paid that you get to keep.

Answer 7

You never pay any money on principal, so you owe the same amount year after year. Buy a cheaper house so you can afford to pay on principal, or just keep renting. I would say it is kinda the same thing as renting, but you're responsible for home insurance (which is way higher than rental insurance) and fixing things when they break., and also paying property tax each year.

Answer 8

The problem is you're never reducing the principal.

If you're in an area with rising home prices, that might not be bad because you'll enjoy the increased value in the home...something you wouldn't enjoy by renting.