When it comes time to taking out a loan for a house, many people do not realize how many options they have. The mortgage can take several different forms. While most people choose a repayment mortgage schedule of either 15-year or 30-year terms, there are some alternative mortgage products that can benefit specific homeowners.
The standard 30 and 15-year mortgages are repayment mortgages. Every payment includes both principal and interest. The payments are calculated so that at the end of the term (usually 15 or 30 years) the house is owned by the borrower completely. Since the payments are designed to remain level throughout the life of the loan, the beginning payments will be largely accumulated interest and a small amount of principal. As time goes on the remaining amount owed on the loan gets smaller, and each payment goes more towards principal. This graph is a great visual representation of what is happening.
Most people will opt for a loan that repays the initial amount borrowed. They will build equity in their home, and eventually they will own the house free and clear. The downside to these types of loans is that the payments are higher than those that include interest only.
Interest only mortgages are set up so that throughout the duration of the loan term the borrower will just pay the interest and no principal. It is important to stress that unless a borrower makes additional principal payments, the principal will never go down by making the monthly payments on an interest only loan. At the end of the term on an interest only loan, the borrower either has to pay off the loan out of pocket, or arrange for another loan on the property. These loans will have lower payments than their counterparts, but the buyer is taking more risk. They are hoping that the house will go up in value, if it does not, they will end up being even more underwater than if they were paying down some of the principal.
Many factors go into deciding which mortgage will work best for the individual. Those who plan to be in their home for many years will want to choose the repayment type; those who think they will be moving soon might opt for the interest only. For those who have a larger cash flow repayment would work better; those who are planning to do quite a few repairs to their new house (as in the case of buying a fixer-upper) they may choose to pay interest only and invest the remainder into fixing the house. Every situation is unique, and the best way to determine if a repayment mortgage or an interest only mortgage fits your financial situation is to talk with your mortgage lender and crunch the numbers. Most people will be served best with a 15 or 30 year repayment, however, there are situations where paying only the interest benefits the borrower.