Is `interest only' mortgage smart?

Q. What is an "interest only" mortgage? We have a 4.875 percent adjustable-rate home loan, but another bank offers 4.25 percent "interest only." Is this a good or bad deal?

Interest-only home mortgages have become extremely popular with home buyers and homeowners seeking to minimize their payments by refinancing.

An interest-only home loan is usually an adjustable-rate mortgage (ARM) with the monthly payment locked in for a specified term, such as 12 months. After that, the payment adjusts, depending on its index plus a margin (like all ARMs).

There are pros and cons. If you expect to stay in your home less than five years, an interest-only mortgage keeps your monthly payments at fully tax-deductible rock-bottom. You won't be paying down the principal balance but, if you will be selling in five years, who cares?

However, many interest-only mortgages have negative amortization, or "negative am." That means your monthly interest-only payment remains fixed for the specified term, but the ARM interest rate adjusts monthly or semi-annually. Any unpaid interest is added to the principal balance. The result is you could owe more than you borrowed.

A variation on interest-only mortgages is the so-called option mortgage. That means the homeowner has the option of paying interest only each month, or partially paying down or amortizing the balance, or fully amortizing the mortgage balance.

The option mortgage would be desirable if you expect to stay in the home many years, but you can barely afford the interest-only choice now. If you expect to earn more income in a few years, you can later start amortizing the mortgage to pay down its balance.

What are people saying about mortgages today:

Rates on 30-year mortgages edged down last week to a seven-month low. Mortgage-giant Freddie Mac reported Thursday that 30-year, fixed-rate mortgages fell to 6.3 percent, down slightly from 6.31 percent two weeks ago. It put rates at the lowest level since they were at 6.24 percent the first week of March.

Bank of Hawaii, Central Pacific Bank, Territorial Savings Bank and Wells Fargo Home Mortgages all cut their 30-year mortgage rates to 5.75 percent this week.

Most people think of a mortgage as a means to an end. After all, you buy a house, not a home loan. But a mortgage is much more than the path to homeownership. It is a financial instrument that must be managed, just like any other financial investment.