Interest-Only Mortgage: Pros & Cons | Chase.com (2024)

FAQs

What is the disadvantage of an interest-only mortgage? ›

Some cons with this type of loan include: You're not building equity in the home: Building equity is important if you want your home to increase in value. With an interest-only loan, you aren't building equity on your home until you begin making payments towards the principal.

Interest-only mortgages can seem more affordable, but they tend to cost more overall; you'll also need to find a way to pay off the loan at the end of the term. Repayment mortgages cost more per month but less over the loan's lifetime - and will pay off your mortgage in full.

The biggest drawback of an interest only mortgage is that you don't pay off the loan as you go. This means you have to find another way to do this – you can't just forget about it. Another downside of an interest-only mortgage is that the total amount you repay over time will be much higher than a repayment mortgage.

Your repayments will increase after the interest-only period, which may not be affordable. The value of an asset such as your house or property, less any money owing on it. . This can put you at risk if there's a market downturn, or your circ*mstances change and you want to sell.

Advantages of an interest-only mortgage

Lower monthly payments, as you are only paying back the interest on your loan. Greater control over your investments, meaning you can decide how you save to repay the capital of your mortgage.

Interest-only mortgages are better suited to borrowers with lots of cash in reserve; borrowers who see their income significantly rising in the near future; and those disciplined enough to redirect income spikes toward paying down the principal.

Important things to consider

There are limits to how long you can have interest only periods – the maximum interest only period at any one time is five years for owner occupiers and 10 years for investors (credit criteria applies). Interest only is not available in the last five years of your loan.

It may be possible to extend the term of an interest-only mortgage, but it will depend on both the lender's discretion and your financial situation. You may need to provide evidence of your income and expenditure and show that you will be able to afford the increased payments once the interest-only period ends.

When your interest-only mortgage ends, your lender will expect you to pay off the loan in full with a single lump sum. Hopefully this won't be a surprise. Your lender should have been in touch with you a year before, six months before and finally just before the end of your mortgage.

Yes, it's possible to refinance an interest-only loan. However, many lenders require a loan-to-value ratio of 80% or lower to qualify. To attain the 20% equity needed to refinance, your home's value will need to increase or you'll have to make extra payments toward the principal during the interest-only period.

Can I switch a mortgage to interest only? ›

Yes, you can change your mortgage from repayment to interest-only. Depending on your situation at the time, you can apply to remortgage onto an interest-only deal. You'll need to check when your current deal ends if you're on a fixed rate, as you could be hit with big fees for changing your mortgage.

Fewer lenders offer them, and banks have set stricter requirements to qualify. Banks generally only offer an interest-only mortgage to a well-qualified borrower. You'll likely need: A credit score of 700 or more.

Cons of interest-only loans

Payment shock: Once the interest-only period ends, the monthly payments will increase as you start paying both principal and interest. This can lead to payment shock, especially if you have not prepared or budgeted for the higher payments.

If you want to make principal payments during the interest-only period, you can, but that's not a requirement of the loan. You'll usually see interest-only loans structured as 3/1, 5/1, 7/1, or 10/1 adjustable-rate mortgages (ARMs).

If the borrower exercises the interest-only option every month during the interest-only period, the payment will not include any repayment of principal. The result is that the loan balance will remain unchanged. For example, if a 30-year loan of $100,000 at 6.25% is interest only, the required payment is $520.83.

A typical interest only mortgage lasts between five and 25 years. It's possible to remortgage to a new deal at any time, which is often a good idea if interest rates have changed. You can also remortgage at the end of the deal – but you will need to meet affordability criteria.

Thoroughly assess your financial situation, risk tolerance and long-term financial goals. Because of the tax benefits offered by interest-only loans, they're often viewed as a good option for investors, but they might not necessarily be the best choice for a first-time home buyer.

Yes, it's possible to refinance an interest-only loan. However, many lenders require a loan-to-value ratio of 80% or lower to qualify. To attain the 20% equity needed to refinance, your home's value will need to increase or you'll have to make extra payments toward the principal during the interest-only period.

Can I get an interest only mortgage? Interest only mortgages are available for home buyers, although they're not as common as repayment mortgages. To get one, you'll need a plan in place to repay what you owe when the mortgage ends. As with any other mortgage, whether you're approved is at the lender's discretion.