An interest-only mortgage allows a borrower to simply pay the interest on the debt without making a principal reduction each month. A reverse mortgage uses the equity in a home to pay the borrower each month, as opposed to the borrower paying the lender.
Significance
An interest-only mortgage requires the borrower to make payments to the lender, while a reverse mortgage is the exact opposite. However, a borrower of any age can get an interest-only mortgage, while only those age 62 and older can get a reverse mortgage.
Function
An interest-only mortgage allows a borrower to make smaller monthly payments, however, the borrower is not building up any equity. In a reverse mortgage, a borrower is cashing in their equity to get rid of their mortgage payment.
Considerations
A reverse mortgage is almost double the closing costs of an interest-only mortgage, however, it is a good option for an older borrower on very limited income. An interest-only mortgage is usually interest only for a short term, and then the payments balloon.
Misconceptions
Many people assume that an interest-only mortgage is a good idea for those looking to only live in the home for a few years, or those who are about ready to get a large raise. However, any number of variables could get in the way of these plans and the borrower should consider the risk involved with increased payments later as well.
Warning
Interest-only mortgages tend to have interest-only payments in the short term, with a set time for the payments to balloon to principal plus interest payments. Additionally, the interest rate on most interest-only mortgages is variable and based upon current market conditions and could, therefore, rise significantly over the life of the loan.
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