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Canadian interest only mortgages

There are basically 2 types of mortgages when it comes to payments.  There are amortized mortgages and interest only payment mortgages.

We have lenders that offer both.  Let me explain the difference between the two, and what the advantages and disadvantages are.

An amortized mortgage is where the entire principal will be paid off at the end of a specific period, through regular monthly mortgage payments.  For example, let's say that you have a mortgage with a principal of $200,000 at 4% interest.  If the amortization period is 25 years, that means that that after 25 years of making payments of $1052.04/mo, you will have completely paid off the mortgage.

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With an interest-only payment mortgage, there is no amortization period.  That means you only make monthly payments on the interest portion of the loan, and do not retire any of the principal.  So, using the same example, with a $200,000 mortgage at 4% interest, you would be making monthly payments of $666.67.  At the end of the term, be it one year or twenty five years, you will still owe the full principal amount of $200,000.

Let's look at the advantages and disadvantages.

With an amortized mortgage, with each payment that you make, a portion of the payment is being used to pay down a portion of the principal.  This is great because with a house probably being the largest purchase that you will make in your lifetime, it is good to know that the size of the debt is being reduced.

In our example, after making payments $1052.04 per month for 5 years, you will have paid $63,122.40 in total.  Of that, $ 25,892.14 will have gone to reduce the principal and $37,230.26 will be interest.  Your new principal balance will be $174,107.86.

The interesting point to note is that almost 60% of your monthly payments go towards interest payments.  Over the course of a 25 year amortization, you will find that much of the early payments go towards interest, and you don't really start digging into the principal until the last 5-10 years of the amortization period.

To give you a laugh (as if there is anything funny about mortgage payments), with your last payment on a 25 year mortgage of $1052.04, $1,048.79 goes to reduce the principal and only $3.47 goes towards interest.    

With an interest-only mortgage, the advantage is that the payments on a $200,000 loan at 4% interest are only $666.67/mo, which is far less than the $1052.04 with an amortized loan.

The disadvantage is that even though you are paying $666.67/mo, you will still owe $200,000 at the end of 1 years, 5 years, or even 25 years.

We usually employ interest only mortgages for short terms, ie 1-2 years.  This period usually helps you get over the hump, keep your monthly payments low, and allows you to pay your bills and re-establish good credit.

Please check with us to see how we can help you.

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