For those who can't afford the monthly payments of a regular mortgage loan, the loan industry has created Interest Only Mortgage Loans. The borrower needs only to pay monthly payments composed of interests and no capital for the first few years of the mortgage repayment program. However, these loans come with some risks that should be taken into account prior to applying.

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.