Interest-Only Mortgages

Go ahead, buy a second home

Traditional interest-only mortgages are similar to adjustable-rate mortgages in that they both have a fixed rate for an initial period, and then are readjusted monthly, every six months or yearly. The only difference is that adjustable-rate mortgages pay both principal and interest in the initial period. After that, both types do.

Why would somebody want an interest-only mortgage?

As the population ages, more and more baby boomers are looking to purchase second homes, where they can gather with family and friends to enjoy each other's company as well as the environment around them; not to mention get away from the rat race for a few days. The vacation home is a sign of success in corporate America.

If you do purchase a second home, how will you finance it? Most people actually use an existing line of credit, but that won't do if you're buying in Vail or Aspen, where starter homes go for $1 million plus. More importantly, how will you handle the monthly payments? The best solution is to figure out when you want to use the place during a given year and then rent it out for the rest of the time. Most resorts have property management services that can handle this for you. Doing so will greatly improve your cash flow.

The bottom line: if you want to buy an appreciating asset like resort real estate, an interest-only mortgage could be just the ticket. More and more lenders are offering 30-year interest-only fixed-rate mortgages with the first five years interest only, and the remaining 25 both principal and interest at the same fixed rate. By making interest-only payments for the first five years, the increased equity built up in your home during this period could well offset the total payments made, giving you a wonderfully inexpensive vacation retreat.

While this type of mortgage makes sense for some, it's not for everyone. There are those who will get used to the lower-than-normal monthly payment and when the initial period is over, won't have adequately prepared themselves for the much higher financial burden. If you haven't thought this out beforehand, you'll be in for a rude awakening later on.

Financial institutions offer interest-only mortgages, like any other lending product, to make money. Remember this when considering your options.

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