What is Interest Only Mortgage? How Does It Work?

Buying a new home or investing in a property is super exciting unless reality strikes and arrangements have to be made to procure a home loan. Choosing a legit mortgage partner is as important as choosing the right home. 

What's an Interest Only Mortgage?

Commercial banks and housing finance companies eagerly await to lend money for home loans to office goers, entrepreneurs, and even independent professionals. We know that the bank charges an ‘interest’ on the principal amount you have borrowed from them to purchase the asset. The borrower has to repay this entire borrowed amount with interest to the lender within a defined time period, as per the contractual agreement. 

With an interest-only mortgage, your initial monthly repayment will be only on the interest charges and not on the original capital borrowed. Say that you have to repay an interest rate of 2.5 - 5% on the borrowed sum of AED 20,000,000 – that means you have to pay only the interest amount for a certain period of time, at the commencement of the loan arrangement. The scheme will give borrowers the flexibility to start repaying only the minimal interest amount and delay paying the principal amount for later. 

How is Interest-Only Mortgage beneficial? 

In the current market scenario, interest-only mortgages are becoming more popular than the traditional formats for the following reasons; 

• The initial payment pressure of having to shell out a huge sum of money every month is not as much in an interest-only loan. 
• The payment of interest-only EMIs goes on for a period that is mutually decided by both parties. 
• It gives the borrower sufficient time to make arrangements to pay the remaining heavy sum of deferred payments later on in the contractual agreement. Till then the asset would have generated some revenue by itself. 

Having read the pros of choosing an interest-only mortgage loan is great, but are there any downfalls to it? 

The cons of Interest-Only Mortgages

• After the initial leeway period is over, the borrower has to pay the remaining interest along with the principal amount that was secured.
• The interest applicable on home loans 5-6 years down the line may increase and now the borrower has to pay the interest as per current market rates along with the principal amount. 
• In the long run, repayment may become expensive and may exceed the amount you would land-up paying in a traditional loan arrangement. 

Interest-Only Mortgage facility in the UAE market 

Within UAE and Dubai, an interest-only mortgage can be availed with limited flexibility. Typically, the lender can grant leeway for only ‘one-year’ period, after which the normal mortgage repayment rules apply. The borrower can enjoy a reduced EMI payment (only on interest) for the first year, after which he will have to pay EMIs on the interest & principal borrowed. This opportunity is a win-win, as it gives some respite to the asset owner for the initial 12 months so that he can plan & prepare for repayment in the subsequent months later. 

Now that you know how an interest-only mortgage loan works, you can be confident & consider purchasing your dream home without much worry about finances. However, borrowers should be cautious while calculating the risk/reward scenario before signing the dotted lines on paper. One must also have a sufficient cash flow to repay the bigger obligations a year down the line (in the case of loan availed within the UAE market) and pay off the loan as per the timelines. Interest-only loans are convenient and will initially free up cash for you so that you don't have any money crisis and your business keeps flourishing as it should.