What Is a Term Mortgage?

Term mortgages can fill a market need.

Term mortgages can fill a market need.

Sometimes what looks like the shortest way to a goal can be the longest. According to TheMortgageProfessor.com, "A mortgage that is interest-only for its entire life has the longest term possible – it never pays off." First-time and returning home-buyers face a bewildering array of mortgage choices -- from traditional long-term, fixed-rate vehicles to adjustable-rate mortgages. Less well known, the short-term, interest-only mortgage can prove a useful, if temporary tool, but one that should be used with caution.

Definition

Technically, the phrase "term mortgage" applies to traditional 30- or 15-year mortgages and adjustable-rate mortgages, as they cover a specific period of time, or term. Most often, however, “term mortgage” identifies a short-term standing mortgage, usually for five years or less, but sometimes for 10 or 15 years. Unlike a traditional mortgage loan amortized over a fixed period, a term loan is usually interest-only, paid over the term of the loan. When the loan-term ends, also referred to as the mortgage “maturing,” the principal becomes payable as a lump sum, known as a balloon payment.

Uses

Term loans prove useful for specific situations, such as in times of rapidly-rising home prices and high inflation, when they allow you to lock in the initial price of a home or investment, often making the lowest possible mortgage payment. Because they exist for a short time frame, term mortgages can let you wait out an inflationary economic cycle. Then, when inflation abates and long-term interest rates fall, you can refinance your home into a more traditional vehicle. And, while you're paying the term mortgage, your entire payment is usually tax deductible.

Term as Investment

A term mortgage leads to other things. At maturity, you need to pay it off in full -- which requires cash or another mortgage. Assume that during the term's time frame, you advance in your job and receive a promotion or two. If you elect to save that money toward a significant cash down payment, you can apply it toward a traditional, lower mortgage. In that sense, using a short-term mortgage serves as a stepping-stone -- an investment yielding a return of a smaller, perhaps shorter, traditional mortgage. When buying a second home or property that you intent to rehab and sell, a term mortgage limits the amount of money you actually invest while giving you a convenient interest deduction.

Cautions

Term mortgages, much like adjustable-rate mortgages, can hold a nasty surprise for the unprepared. Let's say you buy your home with a five-year, interest-only term mortgage at a 4.75 percent interest rate. So far, so good. At year five, you face the entire balloon payment, at a new interest rate tied to economic indexes, according to Financial Web. If your term mortgage matures in an over-heated economy, where interest rates have mushroomed to 12 percent or more, you have a challenge ahead of you. While you can't control interest rates, or predict your employment situation, you also won't know if you're capable of putting money aside to make a dent in that balloon payment to get a lower mortgage, until you start saving.

About the Author

Jan Wondra began writing in 1979 for the "Milwaukee Journal," "Minneapolis & St. Paul Skyway News," Sauk County Media and "Adoptive Family" magazine. She holds a Bachelor of Science in journalism and design from the University of Wisconsin.

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