You are buying the house of your dreams with an interest-only mortgage. You'll get a low mortgage payment, and you'll maximize your tax deduction, all on your current income! Everything seems to be going good. But have you really understood the concept of interest-only mortgage and how it functions.

So What Is An Interest-Only Mortgage?

Well it may break your bubble but there is no such thing as an interest-only mortgage - because eventually you'll have to pay the loan principal as well. In other words, with an interest-only mortgage loan, you pay only the interest on the mortgage in monthly payments for a fixed term. After the end of that term, usually five to seven years, you pay the balance in a lump sum, or start paying off the principal. Net Net! What you're really getting is an interest-only payment method which can be combined with any type of traditional mortgage.

For What Types Of Borrowers Are Interest-Only Mortgages Suitable?

An Interest only mortgage can be an excellent choice for some borrowers, who have a valid use for a lower initial required payment. For most homeowners, paying down mortgage debt is the most effective way to build wealth. Nonetheless, some may build wealth more rapidly by investing excess cash flow rather than paying down their mortgage. Of course for this to hold true, their return on investment must exceed the mortgage interest rate.

The interest only product was originally designed for individuals whose income is cyclical. Borrowers with fluctuating incomes may value the flexibility the IO mortgage gives them. When their finances are tight, they can make the IO payment, and when they are flush they can make a substantial payment to principal.

Financial advisers don't recommend interest-only residential mortgage to regular wage earners who take out moderate-size residential mortgage loans and don't have a strategy for investing the savings.

An interest-only mortgage might be a good fit for:

- someone whose income is mostly in the form of infrequent commissions or bonuses;

- someone who expects to earn a lot more in a few years;

- someone who truly will invest the savings on the difference between an interest-only mortgage and an amortizing mortgage, and who is confident that the investments will make money.

The Final Analysis

Interest-only payments do have a place in the world, at least with the practical users. There are borrowers who can utilize a mortgage with interest-only payments to their fullest. However, it would require careful financial planning on behalf of the borrower to avoid going underwater.

Don’t rule out interest-only mortgages. Consider its pro and cons to your particular situation and the lender you would be working with. On the hind side also remember to question yourself that interest-only payments may be working for friends or family but does it work for you?