When Interest-Only Mortgages Make Sense

While the credit and housing crises make risky mortgage options much less appealing, there are times when a less traditional mortgage might be right for you. One of those is the interest-only fixed-rate mortgage, or FRM.

Interest-only FRMs allow you to cover just the interest charges on your mortgage for the first five to 10 years. After the initial period, principal payments get added to your monthly amount as you amortize your loan over the remaining term of the mortgage.

The interest-only FRM is potentially a good choice for homebuyers who have unpredictable income -- freelancers and people who work on 100% commission, for example. During the months in which your income is higher, you can make additional prepayments that will help pay down the principal. In months when you don't make as much, you can make a lower payment.

But this approach doesn't work if you spend extra income on new clothes or fancy restaurants. An interest-only FRM does nothing to make an expensive home more affordable. If a home is too expensive with a standard FRM, it will likely be too expensive when payments increase on an interest-only FRM.

Interest-only mortgages may also be a good option for homebuyers who live in a market where home prices are still on the rise and plan to move before their principal payments start. Most U.S. housing markets don't currently fit this description.

That said, there are drawbacks: With interest-only mortgages, you aren't paying down your principal at the start of the loan. As a result, after five or 10 years of making payments, you may still owe the same amount you did when you took out the loan. And while you may benefit from the reduced payments at the outset, your monthly payments will jump significantly as soon as you start paying down the principal.