In part one of this series we discussed Adjustable Rate Mortgages (ARM’s) and pointed out why they are not the most viable option for the average homeowner. Today we’ll discuss Interest Only Mortgages (also known as Balloon Mortgages) and their applicable uses but we will also look at the darker side and explain why they can be a trap for homeowners and why they should be generally avoided.

What is an Interest Only Mortgage?
An Interest Only Mortgage is a loan in which for a set term the borrower pays only the interest on the principal balance, with the principal balance unchanged. At the end of the term the borrower may enter into another Interest Only Mortgage, pay off the principal in full, or convert the loan to a principal and interest payment (amortized) loan at the borrowers option.

Who should consider an Interest Only Mortgage?
An interest-only mortgage might be a good fit for someone with an income that is primarily in the form of infrequent commissions or bonuses. Another case is someone who expects to earn a lot more in a few years and believes they will be able to pay the principle in full at the end of the term. Additionally, someone who truly will invest the savings on the difference between an Interest Only Mortgage and an amortizing mortgage, and who is confident that the investments will make money is another prime candidate for such a loan.

Who should avoid an Interest Only Mortgage?
Financial advisors don’t recommend Interest Only Mortgages to traditional wage earners who take out moderate size home loans and don’t have a strategy for investing the savings. Additionally, the cost of the interest in such a loan can be significantly higher than as with a traditional amortized mortgage.

The Federal Reserve Board has more information on Interest Only Mortgage here:
http://www.federalreserve.gov/pubs/mortgage_interestonly/