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Drawbacks of Interest Only Mortgages

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The number of Interest only mortgages has increased in recent years. They provide an opportunity for people to take out a mortgage loan and pay the minimum mortgage repayments possible. However they have been criticised for increasing the total repayment costs to borrowers. The desirability of an interest only mortgage will to some extent depend on your circumstances. However if you are thinking of taking out an interest only mortgage then it is worth bearing in mind these potential problems.

1. You will end up paying more interest payments over the course of your mortgage term. With a standard repayment mortgage the value of your debt diminishes therefore the interest payments decline as the debt diminishes. At the end of your mortgage term, the interest on the debt will be quite small. With an interest only mortgage all your monthly payments do nothing to reduce your debt.

2. Negative equity is more likely. When house prices fall homeowners might be more likely to experience negative equity. With a standard repayment mortgage the value of your debt diminishes making negative equity less likely.

3. Alternative investment schemes can be more risky. In the 1980s many took out endowment mortgages, these are similar in principle to an interest only mortgage. However the investments proved to be generally unsuccessful and so many mortgage owners were left with significant shortfalls. Relying on an alternative investment plan can leave you exposed at the end of the mortgage term because you may not be able to pay back the mortgage loan. It may mean you have to take out another mortgage and be paying into your retirement.

4. Interest only mortgages are more sensitive to changes in the base rate. Taking interest only mortgages means that any change in the base rate will have a correspondingly bigger impact on your disposable income. This has proved to be a problem recently in America with interest only mortgages proving a major factor in record defaults on sub prime mortgages.

5. Interest only mortgages may have a penalty charge if you wish to switch to a conventional repayment mortgage. Check small print of deal as it may be a good option to consider switching if you were able to afford higher payments in the future.

Despite these drawbacks of an interest only mortgage it may still be desirable for many first time buyers. Interest only mortgages have become a workable option for first time buyers to get on the property ladder.


About the Author

Richard Pettinger studied Politics and Economics at Lady Margaret Hall, Oxford University. He now works as an economics teacher in Oxford. He enjoys writing essays on Economic and he edits an Economics Blog focused on UK and US economies: http://www.economicshelp.org/econ.html


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Article Published/Sorted/Amended on Scopulus 2007-04-07 15:18:20 in Business Articles

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