Interest-only home loans are a phenomenon that has been gaining strength and popularity over the last decade or so. The fundamental principle of an interest-only home loan is that the buyer is only responsible for paying the interest on the mortgage for a fixed period of time, often between five and seven years. This sounds fantastic until that interest-only period has expired and its time to pay off the principal, on which you haven’t made any progress since you signed the mortgage. That said, interest-only loans can be right for some people.
The Pros
The best part about an interest-only home loan is obviously that the payments will be significantly reduced for a period of at least five years after initially signing the mortgage. This can allow you to purchase a property that you may not otherwise have been able to afford. You can use the money saved on your initial payments as investment capital in order to prepare for the higher payments that will come down the road. You can also prepare in such a way as to be able to pay off the entire mortgage once the interest-only period has expire.
It should be becoming increasingly clear that interest-only home loans are only for certain types of people. For the person that is primarily paid through commission or bonuses, the loan can be great. During off-months the buyer can make the minimum payment on the interest only; on months when a bonus or commission came in, he can pay off huge chunks of the principal. It could also be good for someone who can reasonably be expecting to make more money before the interest-only portion of the loan has expired. This could be because of an anticipated promotion or an investment opportunity for which the saved mortgage money will be used.
The Cons
Lenders and brokers are pushing interest-only home loans aggressively these days, which should give you some indication that they can be a slippery slope for many types of people. Wage earners and salary earners without a reliable expectation for increased income over the next five years should be cautioned not to sign on an interest-only home loan.
Consider this: if you sign an interest-only home loan with an interest-only payment period of seven years and pay the minimum payment every month for those seven years, every single dollar you’ve paid has been wasted. You still owe your creditor the entire value of the house. At that point you’ll need to begin paying the interest and the principal, and your monthly payments will go through the roof. Buyers should not use an interest-only home loan simply as a means to affording better property now. It should be used to leverage the money saved on the initial payments into being able to afford a better property over the long run. If this does not describe you, you should probably stay away from interest-only home loans.
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