What You Need To Know About Interest-only vs Traditional Mortgage Now

When you are a homebuyer, it’s beneficial to know the many home lending options available for your exciting new Mortgage.

If you’re considering a loan option with lower monthly payments, then interest-only loans might be an option worth exploring. Looking to see what many U.S. homeowners apply for, then you may want to consider a conventional loan option.

How Interest-only Mortgage Works

Interest only mortgages only requires you to make monthly payments towards paying off your overall debt. Instead of this you simply pay off the level of interest that you have on your loan.

With interest only mortgages you get to make monthly repayments around half as much, or less, than they would be if you took out a more traditional type of mortgage deal.

It is important to note that, you are not paying off any of your overall debt, only the cost of taking out the loan that is charged by the lender. Which means that at the end of your mortgage’s term you still have the total amount of debt left to pay off.

However, this is done through what is known as a “repayment vehicle”. Repayment vehicle comes in the form of some sort of investment scheme such as an ISA or another form of saving. When you can’t afford to pay off the amount that is still outstanding on your debt, you will have to sell your home in order to pay it back.

Interest-only loans provide short-term benefits for you, the interest-only period usually lasts about five to 10 years. If your interest-only term ends, the principal amount you borrowed remains and payments towards it kick in. You may decide to move, refinance or apply for another interest-only loan.

The Costs Of Interest Only Mortgages

The cost of interest only mortgages is lesser per month compared to a full repayment mortgages due to the fact that you only need to pay back the interest on the loan each month. Interest only mortgages do end up more expensive over the lifetime of your mortgage because even though monthly payments are lower, the amount of interest that you pay each month will be higher.

The attractiveness of lower monthly repayments is often outweighed by the bigger financial strain that this type of mortgage will place on you in the long run. In addiction, if you want to lower the cost of buying a house, then you are better off going for a standard repayment mortgage than you are by choosing an interest only mortgage.

Can I Get An Interest Only Mortgage?

The fact that interest only mortgages can represent much more of financial burden in the long run, there are stricter regulations upon lenders who offer them. To avoid consumers being landed with debt that they cannot handle and being caught out by what looks like a good offer on the surface.

The Financial Conduct Authority (FCA) has put in place strict laws that force lenders to make sure that the person taking out a loan can afford to repay the debt in full at the end of the term. The loan provider must also make sure that they have assessed the income and spending of an individual to ensure that they could manage payments should there be interest rates rise.

Disadvantages Interest Only Mortgage

Interest-only loan is a smart choice if you’re confident that your income will increase in the coming years, but they still have some drawbacks. Fortunately, there are many loan options for you to consider. The following below are the disadvantages of Interest only mortgage you should consider :

  • They are high-risk, current economic conditions mean fewer lenders are willing to offer interest-only loans.
  • The loans doesn’t build equity. Equity is built through making full loan payments. 
  • Interest-only loans do cost more over time, unlike other popular mortgage options such as ARMs or fixed-rate mortgages. 
  • Time for the full repayments can be a shock. Over years of paying interest only, suddenly switching to a full repayment can hit your wallet hard. Make sure that you can make your full repayments before you accept an interest-only loan.
  • If the home decreases in value, it’ll limit your ability to sell or refinance — a major problem for investors.

How Traditional Mortgage Works

traditional mortgage

The conventional loans are the most common type of mortgage for buying or refinancing a home. They’re backed by private lenders rather than government agencies.

However, Conventional loan monthly payments are higher than interest-only because they combine both the interest and principal amount every month. You can be set up as adjustable-rate mortgages or fixed-rate mortgages.

With an adjustable-rate mortgage you will have an interest rate that stays the same for an initial period of time, then varies once that period ends. but with a fixed-rate mortgage the interest stays at one agreed upon interest rate throughout the life of your loan.

Conventional loans do have more strict qualifications than FHA or other government backed loans, but are typically easier to qualify for than interest-only.

Interest-only loans maybe more competitive to qualify for than conventional loans because they’re considered a higher risk for the lender. However, there isn’t a standardized qualification across the board, but lenders tend to look for higher credit scores and lower debt-to-income ratios for interest-only loans than they usually do for conventional loans.

Disadvantages Of Traditional Mortgage

Conventional loans can be a great option for homebuyers, but before settling on this particular form of financing, do yourself a favor and comb through the pros and cons before making a move. Below are the disadvantages of conventional mortgage loan:

  • Higher credit-score threshold and lower debt-to-income ratios are required with FHA loan
  • Conventional loans require larger down payments, ranging anywhere from 10-20 percent.
  • Meeting strict eligibility requirements overall

In Conclusion

If you want to choose a loan, you should keep in mind both what you’re looking for and what you might qualify for. People who qualify usually get interest-only loans if, conventional loans make up the majority of sale and purchase real estate transactions. When you don’t qualify for an FHA loan or other government assistance programs, you’ll likely apply for a conventional loan.

As an educated homebuyer, as you’re about to finding the best mortgage for you. Speak with your Home Lending Advisor today to find out about next steps. A little preparation can make the mortgage process a lot easier. Do well to learn how mortgage payments works, how to pay them back, and the pros and cons of monthly versus biweekly mortgage payments.

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