Interest-only mortgages are a type of mortgage where you only pay the interest on the loan for a specified period, typically the first few years of the mortgage term. Here’s a detailed look at how they work and their implications:

How Interest-Only Mortgages Work

1. Initial Period: For the initial period of the mortgage (which can range from a few years to the entire term, depending on the loan), you only make payments towards the interest on the loan. The principal amount remains unchanged during this time.
2. Repayment Period: After the initial period ends, you begin paying both the interest and the principal. This period can be significantly more expensive because the remaining principal must be repaid over the remaining term of the mortgage.
3. Types of Interest-Only Mortgages:
• Fixed-Rate Interest-Only: The interest rate is fixed for the interest-only period, providing predictable payments.
• Variable-Rate Interest-Only: The interest rate can change based on market conditions, which means your payments might vary.

Advantages

• Lower Initial Payments: Monthly payments are lower during the interest-only period since you’re not paying down the principal.
• Flexibility: Can be advantageous for borrowers who expect their income to increase in the future or who prefer to invest their money elsewhere during the initial period.

Disadvantages

• Higher Payments Later: When the interest-only period ends, your payments will increase significantly because you’ll need to start paying off the principal in addition to the interest. This can be a financial shock if you’re not prepared.
• No Equity Build-Up: During the interest-only period, you don’t build equity in your property because you’re not reducing the loan balance. This can be risky if property values fall or if you need to sell the property.
• Risk of Negative Amortization: In some cases, if the loan terms are unfavorable or if the property value drops, you could end up owing more than the property is worth.