By John Campbell
Making your regularly scheduled mortgage loan payments without building any equity in your home may be a very bad idea in the long run.
Equity is represented as the current market value of a home minus how much you still owe on it. With traditional fixed rate mortgages, every payment a homeowner makes will build equity in the home. A number of alternative mortgage options available today are doing away with the equity building benefits of fixed rate mortgages. Some may even drain your equity, causing you to owe more money than your home is worth.
With interest only loans, making your regular monthly payment will do nothing to build equity in your home for as long as 5 - 7 years. With each minimum payment the principle amount you owe will stay unchanged. Make interest only payments for 5 years on a $200,000 home and you’ll still owe $200,000 at the end of the fifth year. Interest only mortgages are growing in popularity with homeowners who are strapped for cash or expect their incomes to improve within a few years and with investors trying to invest funds in other areas where they think they can make more money. At the end of a typical interest only term, the entire loan balance will be due as one large balloon payment or a large chunk of the principal will begin applying to each subsequent loan payment until the mortgage is paid off. This can cause the monthly price of the mortgage to go through the roof after the interest only period ends.
If you’ve only made the minimum monthly payments on an interest only loan and need to sell your home before the interest only period ends, you could wind up losing money if your home hasn’t risen in value. With some adjustable rate mortgages (ARMs), you could end up owing more than your home is even worth. ARMS with a capped monthly payment can keep you from paying more than you can afford if interest rates skyrocket. The problem with these types of ARMs is that if the percentage rate rises above your monthly payment cap, any additional interest you owe will get tagged onto your mortgage balance and will have to be repaid eventually. The equity in your home could slowly be sucked away with every month that passes with higher interest rates than you’re currently paying for.
Although interest only mortgages and ARMs can be excellent ways to save money on a mortgage in the short term, not investing in your home’s equity could cost you a lot of money in the long run.
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John Campbell is the writer and editor of CashBuzz, A financial portal for the rest of us. Check out cashbuzz.com for the latest articles on money management and tips and tricks that can help improve your finances. This article may be reprinted on your Web site if the copyright, author information and active link are included.
