Interest-Only Mortgage
First of all, Interest-Only is not a separate mortgage type. It is an option that can be attached to virtually any mortgage repayment plan enriching it with its benefits or disadvantages (or both). Interest-Only has different effect on different plans, but it practically always makes the overall cost of a mortgage higher, as well as brings certain quite pressing issues into the sums to be paid monthly when the interest-only period is over. Always study the advantages you buy at the price thoroughly - they have to be really worth it.
The idea of the Interest-Only option is that your monthly payment pays in fact only the interest. You sort of pay some “salary” to the lender for using his money, but it remains his money anyway, as well as your (still potentially your) home remains his, too. No mortgage is 30 years interest-only nowadays, so eventually you are expected to start paying the principal off - only at that stage you will start to really buy out your home.
The interest-only option can be attached to both a Fixed Rate Mortgage and an Adjustable Rate Mortgage. The interest-only period does not usually exceed 5 years. After that, you should be able to start making regular (interest + principal) monthly payments.
With a Fixed Rate Mortgage the amount of monthly payments remains the same throughout all the 5 years of the interest-only period, because the rate is fixed and the principal is unchanged, unless you make extra payments.
With an Adjustable Rate Mortgage, however, monthly payments have to be adjusted to keep up with the changing rate. The interest-only period of an Adjustable Rate Mortgage does not imply by default that the rate will stay fixed all through the time, unless you make a special arrangement for that, most likely, at the cost of the general rate increase. The balance of the loan remains the same, if you make no extra payments, but the rate changes according to the index and other provisions stated in the contract, so the payments have to be adjusted regularly, too.
Now, about the extra payments, I mentioned above. In theory, every time you make an extra payment, its amount should be subtracted from the loan balance, and the next after the extra payment month should already claim a lower interest-only amount, recalculated on the new lower balance. In reality, it is not always the case. If you expect, that you will be able to pay extra from time to time during the interest-only period and you want the appropriate changes to take effect immediately, make sure the monthly adjustment is in your contract. Otherwise, the adjustment will only take place at the regular adjustment time with an Adjustable Rate Mortgage, and may not take place at all for as long as 5 years with a Fixed Rate Mortgage. I don’t mean to say that your money will be lost or wasted completely in that case, but it will not show its return as soon as you may want to expect it. If you, for example, make your extra payment in month 2 of the interest-only period of your Fixed Rate Mortgage, the effect of this payment, unless stated otherwise in the contract, will become apparent only in 5 years, i.e. when the interest-only period is over. As you come to the stage of paying both the interest and the principal, you will probably be pleased to find out, that your balance has declined due to your years-ago extra payment, but at what price? It may so happen that the same money deposited in a bank rather than paid for the mortgage could have gained you a much better return through these years.
When the Interest-Only period is over, you are expected to be able to start regular (interest + principal) monthly payments according to your mortgage plan to amortize the loan completely. This is the hardest part, because with, say, no extra payments made during the Interest-only period, you now have to face the full balance as it was at the loan origination to repay within even a shorter period of time than the original term. This is the price you pay…
An Interest-Only mortgage, however, can be helpful to people, who want to buy a home now, but lack immediately adequate financial resources. If you are sure that your income will rise in 5 years to the extent that the new monthly payments will not ruin your family budget - the Interest-Only option can be for you, too.
Another situation quite appropriate for an Interest-Only may occur when people start a business of their own and mortgage the property, where the business will run. The money saved on the loan payments can be invested into the business early development.
