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
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
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.