When a mortgage becomes a miracle

How do `interest only` mortgages work?

According to the Council of Mortgage Lenders there are currently six million homeowners who have interest only (IO) mortgages, and are paying only the monthly interest on the loan. Not having to pay down the principal for the first five to ten years can provide enormous benefits. Borrowers can use the extra cash to build savings and reduce debts. Interest only loans can also help you cover a larger mortgage and buy a property you might not have been able to afford otherwise.

However, low payments don’t last forever. At some point, depending on the agreement with the bank or building society, these mortgages become regular ones. Unless you sell the property or refinance, your monthly outflows will increase dramatically. Furthermore, IO mortgages usually become adjustable; payments will change in line with rate fluctuation.
How do IO mortgages work?
Interest only is not a type of loan but an option that can be attached to most mortgages. Usually between five to ten years the home loan becomes fully amortizable. This means that after this term you will start paying both, interest and principal, each month. This option makes the principal increase more that if you had started paying it from the beginning, given that now you will be paying it off in less time.
Rates can be up to one quarter of a percent higher for these mortgages. However, borrowers consider that a trade-off for having at least five years of low disbursements.
The problems ahead
The main disadvantage of taking an IO mortgage is that at some point you will start disbursing thousands of pounds more per month to start paying the principal. Furthermore the real estate market might not stay as hot as you expect and house prices might not keep rising. In such case, if you sell before your principal free period is over, you might end up paying a big chunk of the mortgage as well. The whole investment will be a loss.
Also be aware that these are secured loans. If you do not respond for the signed agreement your home might be repossessed. Interest only borrowers are also supposed to have an endowment or independent savings account (ISA) that shows they will be able to pay at least part of the outstanding principal later on. If you decide on taking an IO mortgage be conscious that the high payments are ahead, and plan. Review your budget and figure out how you will finance these outflows. If you find that selling is not a profitable option, you can consider refinancing; a new loan can help covering the premium. In such case you must accurately control that double debt. You should develop superior discipline and pay back on time to avoid repossessions or increasing interest.