This article requires that we define two common lending terms:
Principal: The amount of money that you owe the lender.
Interest: The amount of money that you pay the lender in exchange for borrowing the money.
What is an interest only mortgage? Simply put, it is a mortgage that requires that you only pay the interest each month – most mortgages require that you pay both the interest and principal down with your payments.
But, why would you want a mortgage where you only pay the interest? There are many reasons; however, we will focus on the main one right now:
- If you own a rental property (in Canada, I have been told) that you can write off your interest payments; however, you cannot write off the interest that you pay on your primary residence. The theory is that (if you have a mortgage on your home) AND one on your rental property – then you would get an interest only loan on your primary residence, pay only the interest and take the funds that you would have paid on the interest on your rental and pay down your primary residence. That way – you can pay down your house mortgage faster and the interest that you pay on your rental property is not as high since you can write it off (and avoid tax).
There are many different types of loans/mortgages that allow you to pay interest only; HOWEVER, there are typically only two types of loans that allow this:
1) HELOC (home equity line of credit) – can be seen as a giant credit card that is secured against property (real estate).
2) Private mortgage – “private” basically mean “non-bank (most often an individual lending the money)”. The reason why they do this is the higher the balance – the more interest you pay to them over time. Banks don’t love these types of loans because they are never sure how they will escape, most bank loans have payments that will result in you eventually paying it out over time – if it is interest only (and you never pay extra) you will never pay it out. Now you may ask why a private lender would entertain this over a bank? Quite simply, banks have lots of loans (and they hate foreclosing) – private lenders don’t often have too many loans and are therefore looking for maximum returns, whereas the bank (who isn’t charging nearly as much) just wants to be safe.
Trevor Hickey, B.A. is a mortgage associate who works in Calgary with Concord Mortgage Group Ltd. (a team of Calgary mortgage brokers).
