"Interest only" products are an easy way to save money and a very popular alternative to traditional fixed rates but they are not without risk. An "Interest Only" loan can offer consumers greater purchasing power, increased cash flow and a number of other benefits which are listed later in this article.
First let us start with a quick explanation of how the product works. With Interest only loans the borrower has the flexibility of paying only the interest due on the mortgage. Most of these products allow you to pay extra if you choose.
The positive aspects of these loans are as follows:
- They work well for borrowers that are restricted by a tight budget, and the savings can be as much as $300-400 per month!
- Interest Only loan can allow you to qualify for a bigger home. If the underwriter considers only the "Interest Only" payment, you may be able to upgrade to a nicer or larger home.
- This type of loan works well for people who only want to stay in a home for a just a few years. During the first couple of years with a conventional 30 yr mortgage, most of your mortgage payment is being applied directly to the interest of the loan. If you want to stay in the house for only 3-5 years, an "Interest Only" loan may be the right loan for you. You can receive a lower payment and have almost the same principal balance as the borrower who chose a 30 year, conventional mortgage if you choose to sell in 3-5 years.
- You want to buy a very expensive home. Most people who buy very expensive home have no desire to pay off their home completely, and the rate of appreciation on the house is usually very good. An "Interest Only" loan allows these borrowers to deduct their interest payments, and the money they save can be directed to other investments.
- You want to buy a rental property. The lower payment can help improve cash flow on a rental property.
As with every loan program, with positives there are always negatives.
- You are not paying down your principal on your mortgage. If your property doesn't appreciate in value over those 3-5 years, you may even have to pay money if you choose to sell the home. While the likelihood of this happening is high, it is a risk that must be considered when thinking about using Interest Only loans.
- Most "Interest Only" products have a specified term. For example, on most 30 year fixed "Interest Only" loans, most lenders allow interest payments for 10 years, and then you must repay the loan during the last 20 years. This loan now must be amortized over a 20 year period, and this will carry a higher payment than a 30 year fixed mortgage. These loans may be a good option for you as a borrower, but each person's situation is unique.
- Lastly, when in a period of incredibly low fixed rates "Interest Only" products will be very attractive. But, if you are planning on staying in your home for an extended period of time, you may want to consider a traditional fixed product.