What Is a Self Liquidating Mortgage?

Self-liquidating mortgages work by parceling, or amortizing, your money out. Every month, you pay the interest due on the loan and a piece of the principal. Next month, since you owe less money,you pay less interest, which means more of your money goes to the principal. This process continues through the life of the mortgage until you finally make a last payment that contains almost no interest and completely pays off your balance.

Mortgages were originally interest-only loans that needed to be refinanced every five or so years. After the Great Depression, self-liquidating loans became more prevalent due to support from the Federal Housing Administration and the growth of the savings-and-loan industry. Its popularity waned a bit during the high inflation and interest rates of the early 1980s, but picked back up after interest and inflation rates dropped later in that decade. As of the fourth quarter of 2012, the 30-year fixed rate mortgage, which is self-liquidating, was the most popular type of mortgage in the United States.

With an interest-only mortgage, your monthly payment doesn't have any principal. If you borrow $250,000 on a fixed-rate 5 percent interest-only loan, your payments will be $1,041.67 per month until the loan period ends. When it ends, you'll still owe $250,000 and you'll need a new mortgage. The key benefit of an interest-only loan is the low payment. For comparison, the payment on a 30-year fixed loan of the same size and rate would be $1,342.05.

Balloon mortgages work like a self-liquidating loan with one key difference: they end before the balance gets paid off, leaving you to refinance. Since the lender is committing to you for less time, you can usually get a lower interest rate with a balloon loan. However, since you pay more interest than principal in the beginning of your loan, you could have a longer payback period. For example, with a 10-year balloon loan with an amortization schedule, you'll pay about 19 percent of the loan's balance, even though 10 years is 33 percent of the life of a 30-year loan. When you refinance the balloon, you'll have to start again.