Freddie Mac, one of the two main government-sponsored institutions that set lending standards for home mortgages announced recently that it will be phasing out interest-only loans. This is expected to drastically shrink the number of interest-only mortgages available to consumers.

Freddie Mac has already begun the phase-out after losing money on the loans over the last three years. Nearly one in five interest only loans that Freddie Mac holds are at least three months delinquent. Fannie Mae has also incurred big losses on these types of mortgages but the company has not yet said whether it will phase them out as well.

While smaller lenders say they will continue to make interest-only mortgages available, the lending standards are getting a lot stiffer. Typically consumers select a fixed-rate or variable-rate mortgage and pay only the interest on the loan or the first 10 years, after which they pay for principal and interest for the next 20 years.

Borrowers with good credit can get adjustable-rate interest-only mortgages with a 4.5 percent interest that is fixed for five years. The rate then increases a maximum of five percentage points over the next five years. Under the new tougher lending standards a consumer would have to prove they would be able to pay the fully indexed rate of 9.5 percent.

As a result of the new standards, interest-only mortgages are considered a good fit for only wealthy individuals who need flexibility in their cash flow and who do not intend to own their home for long.

The bottom line: Interest-rate mortgages are not for everyone. If you are considering this type of loan be sure you can meet they monthly payments once the principal portion of the mortgage kicks in, most likely at a higher rate.

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