There's a yin-yang quality to every facet of life. It's not so surprising, therefore, that it even holds true for fixed-rate interest only mortgages. These mortgages, which are becoming a hot item for many cash-strapped homeowners, are making up an increasingly large portion of many lenders' portfolios.

New home mortgage of choice

The rise in popularity of these loans should hardly come as a surprise. There's plenty of attractive "yin" to this deal. Homeowners like the low monthly payment that comes standard on fixed-rate interest only mortgages, especially in a rising interest rate environment. However, before you jump, take a closer look of the not so appealing "yang" that you need to watch out for if you choose this loan instrument.

Potential pitfalls of a mortgage refinance

Big payments down the road. Like its cousin the ARM, the fixed-rate interest only mortgage offers low upfront monthly payments. This is ideal for the homeowner with cash-flow problems. But, after a period of about 10 to 15 years, the other shoe drops. That's when principal payments start coming due, and the monthly payments increase significantly. It's not uncommon for payments to jump by 30 percent or more when the rate adjusts.

Higher interest rate in the long run. While the initial payments are low, the overall interest rates of these loans tend to be higher when compared to a 30 or 15-year standard fixed rate mortgage. This can result in additional long-term interest costs unless you refinance or sell your home before the end of the loan's full term.

Refinancing options

Now that you understand some of the pitfalls of this type of mortgage, it's time to study the options that can make the fixed-rate interest only loan desirable.

First, you can make additional principal payments. As hard as that may be on your budget, any additional principal payments will help reduce the size of the interest-only payment.

Second, you can refinance or relocate before the 10- or 15-year adjustment occurs. You may have to make a move when the readjustment period ends, so give yourself plenty of time to make financial arrangements.

There isn't a mystical quality to the lower monthly payments of the fixed-rate interest only mortgage. Instead, the yin-yang principle holds true--there's plenty of downside to go with the upside. However, by adhering to a few of the strategies mentioned above, you can use this type of mortgage to get through either a high interest-rate environment or some budgetary woes. Play by the rules, and you could come out ahead in the end.

Published on August 19, 2010