These risks may imply that you’ll end up paying significantly higher amounts on the long run or worst that you may loose your property if you are unable to meet the monthly payments whether it is in the first stage of the loan repayment program or in the second one when the monthly installments turn more onerous due to the inclusion of the loan’s principal.
Overpaying Interests
To cover for the expected losses due to a higher default rate that these kinds of loans have, the lender will charge a higher interest rate than that of regular mortgage loans. This will imply that even if you get lower monthly payments at the beginning of the loan repayment program, you’ll end up paying a lot more on the long run.
Also, since you are not canceling any principal, the interests are always calculated over the whole loan amount as opposed to regular mortgage loans where the loan’s principal gets reduces every month and so do the interests on the loan. This fact alone implies huge savings that you are walking out on by choosing an interest only mortgage loan.
No Equity Generation
During the first years of the mortgage repayment program, you won’t be generating any equity on your home. Equity is the difference between the property’s value and the amount of debt secured by it. Since with interest only mortgage loans you don’t cancel part of the principal at the beginning of the repayment program, equity won’t increase.
Equity is very important because you can always resort to it when you need finance during an emergency. If something happens and you can’t afford the monthly payments on your mortgage loan you can always refinance and obtain cash of your property to get back on track. But if you chose an interest only mortgage loan there will be no equity available and thus, no chances of obtaining extra cash out of your property.
Greatest Risk: Variable Interest Rate
If you selected an interest only mortgage loan because you couldn’t afford the monthly payments on a regular mortgage loan, you should be especially careful with variable interest rate mortgages. An interest rate variation can affect the monthly payments on a regular mortgage with variable rate slightly because only part of them is interests. Yet, on Interest Only Mortgage loans it can be disastrous.
An increase on the interest rate on a variable rate interest only mortgage loan can imply a significant raise on the amount of your monthly payments, and thus you may be unable to afford the monthly installments on your loan. Thus, if you choose an interest only mortgage loan try to make sure that you get a fixed rate mortgage or at least that you have enough available income ready in case your monthly payments increase.
Joycelyn Crawford
http://www.articlesbase.com/mortgage-articles/risks-of-interest-only-mortgage-loans-121417.html
Comments
Why are mortgage loan interest rates higher for fixed rate mortgages held for longer periods of time?
I am sorry if this sounds like a dumb question, but I don’t understand. For example, why are 30 year fixed mortgage rates the highest mortgage rates, vs say a 15, and why are 15 year fixed rate mortgages higher than adjustable rate mortgages ? It seems that lending institutions are taking greater risk with a ARM vs. a Fixed rate mortage and they should pay a higher rate (For example, compared this situation to a new car loan vs a used car loan–the risk is higher on a used car loan ?? ??
I can understand a fixed rate loan of 30 higher than a 15 –greater risk of default from the borrower, BUT I still don’t get the ARM being so low.
30 years takes longer to get your investment back (less on the front and more on the back of the loan). Adjustable rate the lender is hoping for the rate to be higher when it adjusts or it is set for a given time to adjust up no matter what the rate is. On a 15 year the default is lower due to being 1/2 the time.
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certified appraiser
The reason a 30 may be more interest than a 15 yr is because there is more risk that interest rates could increase during that time and the bank could be losing money at that rate vs. making a subsequent loan at higher interest. The reason that variable rates are lower is because they could follow any increasing interest rates up. I forget what the variable rate was on the free HELOC my lender gave me during a refi in 2005, but that interest rate had gone as high as 7.5% between then and the 3.75% it is now. But I also remember a time when normal mortgage interest rates were double digits, high enough that a bank offered me a discount if I paid off a 10% land contract early.
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The lender is taking basis risk on longer term loans since no one knows where rates will be in 15 or 30 years. The bank looks at the yield curve and prices the loan based off of a spread for 15 and 30 year product. ARMs are cheapest because they recast earlier and there isn’t as much interest rate risk in the short term.
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