What’s the catch with companies that offer mortgages with such a small monthly payment?
Valerie RumboughYou’re describing a typical interest-only mortgage, and yes, there is a catch. Mortgage lenders often tout them as the answer for those who either are looking for lower payments or a lot more house.
If you’re a disciplined investor, good with money, a bit of a risk-taker and not buying more house than you can afford, an interest-only loan could work for you. However, if you’re not all of those things, you probably want to stick with a more conventional mortgage.
In the beginning, an interest-only mortgage requires you to pay interest only for the first five years, at a rate that could be around 3.75 percent. However, in the sixth and eighth years, the interest rate increases up to an additional 3 percent each time. It does the same in the 11th year, only now you must begin paying back principal.
In dollars, this means that monthly payments on a $100,000, 30-year mortgage would start at around $323 and end up at $956 in the 11th year. It could end up costing you more than a 30-year, fixed rate loan, which would require monthly payments of $600.
Interest-only loans do have their place, however. For instance, those who plan on only staying in their house five to seven years may see this as a good move. Just remember, though, that when you sell, you have no equity in the house unless it has appreciated in value.
The bottom line is to know what you can afford, both now and in the future, before deciding how to finance that home purchase.
Rumbough, CPA, CFP is vice president of finance with the Baptist Foundation of South Carolina. For more information concerning the above topic, contact her at 800-723-7242.
(Editor’s Note: In accordance with IRS Circular 230, this article is not to be considered a “covered opinion” or other written tax advice and should not be relied upon for IRS audit, tax dispute, or any other purposes.)