How to Understand Interest Only Home Loans

Written By: Dominic K. Kimbell on October 1, 2009 No Comment

by Dominic K. Kimbell

When you make your monthly mortgage payment, part of it goes to pay the bank its interest, and part of it goes to pay down the loan. That?s the way a typical mortgage should work. Some banks have now introduced a new type of loan to attract more borrowers by keeping the monthly mortgage as low as possible by only paying the interest.

This means that if you choose an interest only option, each month you pay your mortgage, the loan balance stays just the same; it never gets lower. Of course, most lenders will let you pay more than the minimum interest payment any time you want, but that defeats the purpose of the loan, which is to keep the monthly payment as low as possible.

Interest only loans were based on the theory that it doesn?t matter that the principal was never reduced, because when the house was sold, the additional value would allow the borrower to pay off the loan. Equity was built by a combination of loan paydown and increased housing values.

But the housing market now does not mean that you will gain equity in your home just by market increases. The only reason that one would prefer to have an interest only loan is to keep the monthly mortgage as little as possible. This might be valid option if it were a temporary situation.

A good example would be if one partner to the mortgage was attending school and the other was working. Since, in theory, the student would eventually complete his studies and get a good job, keeping the mortgage payment low during this period and ramping them up afterwards makes sense.

Another valid situation would be if the primary income owner had an erratic earning pattern, in which he had little to no earnings for a time and then a windfall income. Maybe a project consultant is only paid at the end of a project. While the project is underway, it is best to keep payments as low as possible, a need the interest only mortgage could meet, and then when income comes in, higher payments can be made.

In any of these cases, it is dangerous to not boost the payment at some point in order to bring the loan balance down. If you are paying off the principal a little at a time each month, when it comes time to sell the home, you earned some equity in it, even if housing prices have not gone up. If you only pay the interest each month, you will never reduce the principle, and if the home sales price is lower than the mortgage, you will not be able to pay down the loan.

About the Author:

Thank you for your interest in our article.Start saving money onlife insurance Albertaalso considerlife insurance British Columbia