Interest Only Mortgage

Interest Only Mortgage

interest only mortgageThe interest only mortgage is straightforward.  The borrower takes out a lump sum of money and only repays the interest due each payment period.  This means that, throughout the life of the mortgage, the borrower will always owe the same amount of principal.

For example, given a mortgage of $200,000 with an interest rate of 6% compounded semi-annually, not in advance, over a 1-year term, the borrower would be making monthly repayments of $987.73.  An interest only mortgage does not have an amortization since there is no repayment of principal.  

Mortgage brokering in Ontario is regulated by the Financial Services Commission of Ontario (FSCO) and requires a license.  To obtain a license you must first pass an accredited course.  The Real Estate and Mortgage Institute of Canada Inc. (REMIC) is accredited by FSCO to provide the course.  For more information please visit us at or call us at 877-447-3642.

Benefits of an Interest Only Mortgage

Increased Cash Flow
From a borrower’s perspective, the fact that no principal is being included in the mortgage payment typically results in a lower payment than would otherwise be the case in an amortized mortgage.  This may be beneficial to a borrower who knows that he or she will be receiving an increase in income in the near future.  Once that increase is realized, the borrower can switch to a blended payment mortgage.

Increased Purchasing Power
If, however, the borrower wishes to keep the payment at the same amount as he or she would have been paying in a blended payment mortgage, he or she will be able to borrow more money than otherwise possible.  See the following figure for an illustrated example.

If this type of repayment plan is used to purchase an investment property, for example, the investor can deduct the interest paid as a cost of investing.  Under this scenario, the investor is able to purchase a property at a higher value than using a blended payment repayment plan while using the income from the property to make the mortgage payments. 

Risks of an Interest Only Mortgage

No Principal Reduction
The fact that there is no principal reduction can put both the lender and the borrower at risk.  The risk to the lender is that, if the borrower defaults and the property does not appreciate, their principal may be at risk, depending on the loan to value.

For the borrower, if he or she uses this repayment plan to increase his or her purchasing power and property prices decrease, he or she can end up owing more than the property is worth.  The interest only mortgage is one of the factors that contributed to the mortgage crisis in the United States in 2007.

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