Interest Only Mortgage vs Typical Financing

An interest only mortgage can be a valuable investment tool.  However, you must be very cautious using this method.  There are many dangers surrounding the use of an interest only mortgage.  In a nutshell, an interest only mortgage is a mortgage that the borrower makes very small monthly payments (to cover interest only) and then is required to pay a fully amortizing payment at the end of the interest only option period.  Get the details on an interest only mortgage.

Typical fixed loans amortize, or pay down in increments, the principle balance of the mortgage over time.  However, paying down part of the principle balance over time increases the monthly payment.  This is the advantage of the interest only mortgage, as you only have to make small monthly payments, providing a great tool for short term real estate investments.

In my opinion, buying a house in a fast paced, quickly appreciating market is the best place for the use of an interest only mortgage.  Let’s take a look at the following *example (there will be a link at the end of the post to download the spreadsheet):

Interest Only Mortgage vs Typical Financing

As you can see from the example, in a fast moving market, you stand to do substantially better with an interest only mortgage.  However, be cautioned that if the market doesn’t move fast, or declines, you will end up without any equity, or possibly negative equity with the interest only mortgage.  Since most interest only mortgage options have a period of 5 or 7 years, you need to carefully plan your investment, considering up front cash, ability to rent, and a definitive time line for getting out of the investment, otherwise when your payment increases to the full amortizing amount, you may not be able to afford the payments, and may have to sell, or refinance the mortgage.

I am typically a little more cautious, and tend to go for the fixed type of loans.  I want to see performance over many years, not just a quick buck.  I am in it for the long haul, but if you have a little more guts, the interest only mortgage may be for you.  You may download the spreadsheet here:

Interest Only Mortgage vs Typical Financing.xls

*The example shown and available in the spreadsheet are purely estimations, and not based on real data.

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