Pay Off Interest Only Loan with Mortgage Refinancing

An interest-only mortgage is unique because of its amortization schedule. Whereas most loans are paid back in monthly installments of both principal and interest, the interest-only home mortgage allows that no principal be repaid during the first payback phase. This results in lower monthly payments. Also, since mortgage interest is generally 100 percent tax deductible, it also rewards the borrower with a hefty savings around tax time. But after a period that usually extends for the first few years of the loan, the amortization changes. Principal is tacked on to each monthly payment, and the chunks are large enough to make up for the preceding interest-only phase.

For instance, a $250,000 conventional 30-year fixed-rate mortgage with a 6 percent interest rate would be paid back in monthly installments of about $1,500. But an interest-only mortgage for the same amount might begin with payments of only $1,200. Once the principal repayment phase starts, however, those payments could jump to $1,600.

Most people who take out an interest-only mortgage do so with the intention of selling their house in a few years and paying off their loan. They don't plan to keep the property long enough to experience the higher rates. Others use these types of loans if they anticipate higher income in the future. A medical student, for example, might choose an interest-only mortgage with the expectation that, within three to five years, he'll be working as a highly paid doctor who'll be able to afford higher payments.

Mortgage refinancing saves the day

For many people, refinancing is the best choice if they want to stay in their home without the possibility of dramatically higher monthly payments. If you have an interest-only loan and pay it off by refinancing into a low fixed-rate mortgage, you can get a competitive rate that will not accelerate during the life of the loan. And the interest portion of the payment is still tax deductible. For most people, that kind of predictable security is invaluable.

If you'd like to take advantage of refinancing your mortgage to a more comfortable fixed-rate mortgage, act quickly. Remember, "He who snoozes, loses." Rates are moving higher, and those who procrastinate may miss the boat and find that a few months down the road, those attractive rates will have sailed into the sunset, replaced by numbers approaching double digits.