What is an Interest-Only Mortgage?

Due to the increasing prices of homes in Canada plus the mortgage stress test, securing a mortgage for Canadian maybe a bit challenging.  If you are frustrated by the housing economy – you are not alone.

Because of these reasons, Canadians are turning to alternative forms of mortgages to successfully purchase a home. One variation of a traditional mortgage is an interest-only mortgage.  An interest-only mortgage in Canada is one type of traditional mortgage. If you want to know more about it keep reading

Interest-only Mortgage Explained

As the name itself, interest-only mortgage this is a type of loan where a borrower pays interest with their monthly payments.  Principal repayment will be done if the borrower makes and extra payment for principal and interest.

The interest-only mortgages are usually structured with the option to make interest-only payments, but it is not mandatory. This means if the borrower could make regular payments with the principal included and exercise their interest-only option when they face financial struggles.

This is a type of loan is a fixed rate and typically lasts between five and seven years. Once the term is up, instead of paying for the interest rates, most borrowers refinance their mortgage, begin to pay the principal of the loan. If the borrower decides to start making principal payments, the amount will significantly increase. An interest-only mortgage sounds fantastic because your monthly payment will be lower without the principal amount. You have to keep in mind that the borrower still owes the principal amount, they simply are delaying the timing of principal repayment.

Traditional mortgage vs. Interest-only mortgage

An interest-only mortgage is a type of mortgage and shares many qualities with traditional mortgages. However, the interest-only component may also have some differences.

Let’s explore the similarities and differences.

Similarities

Used to Purchase a Home. A mortgage broker in Canada offers traditional and interest-only mortgage covers the cost of a home that the borrower cannot cover themselves.

Involve Regular Payments. Both types of mortgages require you to make payments on specific dates. The amounts vary, as a borrower, it is your responsibility to make full payments otherwise your credit score will suffer.

Differences

Principal Repayment Timing. Both require you to repay the principal. The difference is timing, for a traditional mortgage involves immediate principal repayment whereas an interest-only mortgage you may delay the principal repayment.

Who Should Consider An Interest-Only Mortgage?

Interest-only mortgages have a unique structure. May only applicable to some circumstances. Below is a list of scenarios where an interest-only mortgage is desirable.

  • If you are purchasing and selling the property in a short period.
  • Can afford a large payment increase in the future in exchange for a lower payment now.
  • If you do not earn a flat salary and have a variable salary instead.
  • Can earn more with your money elsewhere in the short term.
  • You’re a first time home buyer

Pros and Cons of an Interest-Only Mortgage

Before making your decision to proceed with an interest-only mortgage, it’s important to consider the pros and cons. Knowing the advantages and disadvantages can ensure that the choice suits your personal financial situation best. Let’s explore the pros and cons below.

Pros

Low initial monthly payments. Monthly payments are lower at the beginning of the term.

Earn Elsewh When you use the extra cash elsewhere you can earn more instead of putting it up towards the principal.

Cons

Little Value Appreciation. There are some uses interest-only mortgages expects that the property’s value will increase and they can turn a profit by selling it in a few years. But, if the home does not appreciate, or worse depreciates, the borrower could wind up in a bad financial situation.

Don’t Use Idle Money Effectively. With a reduced mortgage payment you may end up overspending. The idle money should be invested elsewhere and will put toward the mortgage principal or other home ownership costs.

Risk of No Income Growth. There are some people who use an interest-only mortgage with the expectation that their income will grow in the future. If this expectation doesn’t happen, you could end up in a tough financial situation.

Unable to Afford Principal Payments. When you need to make principal payments, many aren’t able to afford them. Besides, most people aren’t good at putting extra money toward their mortgage. This concept Is commonly known as “payment shock” because it certainly can be a shock!

Is An Interest-Only Mortgage Right For Me?

Interest-only mortgage us a unique financial product. This is not the type that all people use regularly. But this doesn’t mean that an interest rate mortgage is not right for you. Before you consider getting this type of mortgage make sure that this will not hurt your finances in the long run. But if you think that you will benefit from this type of loan, you should go for it.

 

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