Interest Only Mortgage Loan - Advantages and Disadvantages

What are the benefits of interest only mortgages and why are they so popular?

2 Answers

Interest-only mortgage loans are like regular home loans but instead of paying monthly principal and interest on the loan, only the interest is paid for the first five or ten years, usually the term of the loan. Interest-only mortgages provide a popular way for homeowners and investors to take advantage of a cheaper and more affordable mortgage option. By only paying the interest on this mortgage loan, the homeowner or investor can invest, what would be their principal payment, in stocks, savings, or a small business. The bet is the investment will outperform a standard mortgage loan for the first 5 to 10 years. And after the 10 years is up, the interest-only mortgage loan holder will have the money to refinance or pay of the mortgage in a lump sum.

So, why should the prospective home buyer or investor sink his discretionary income into the principal of a standard mortgage loan when he can instead use that principal as a better investment hedge against paying higher mortgage rates, enhancing personal wealth?

Interest-only mortgages are not new and is not a new type of mortgage. Think of it as a mortgage option instead of mortgage standard, much like people didn't do during the 1920's. Interest-only mortgages were the standard mortgage back then. After the Great Depression, interest-only mortgages and ** foreclosures** meant the same thing. Home values fell, and most homeowners were stuck with their interest-only mortgages worth more than their homes. Foreclosures skyrocketed.

These types of loans are not advised for most regular homeowners and wage earners who are not versed in investment and saving strategies.

** **Interest-only mortgage loans may be advantageous for the following audience:

  • practiced investors who are confident that principal payments, ordinarily paid on a standard 30-year, fixed mortgage or ARM, are instead invested in a stock instruments that will make money

  • people who's income takes the form of infrequent bonuses or commissions

  • people who expect to make a lot more money in the near future

In the mind of many financial advisors, the disadvantages of interest-only mortgage loans trump its advantages.

Interest-only mortgage plan disadvantages include:

  • if it's an ARM, rising mortgage rates heightens risk

  • many people will not invest or save the extra money and spend it instead

  • many people are not disciplined enough to pay the extra money on principal payments when they don't have to

  • anticipating income growth may fall short

  • anticipating home appreciation may fall short

An interest-only mortgage program has its pros and cons and is not for everyone. Many banks and mortgage lenders hawk this program as a new type of mortgage to first time homebuyers and speculators. First time homebuyers can now afford to enter the housing market with affordable, low interest-only mortgage payments. Homeowners looking to upgrade can leverage the interest-only mortgage loan into a higher priced house that otherwise would be unaffordable.

Unfortunately, misconception and hyperbole make interest-only loans the loan du jour for a lot of prospective, new homebuyers. Many banks and mortgage loan companies are good at answering questions regarding the benefits of interest-only loan programs, but they also omit the disadvantages of these loans.

An interest-only loan is not inherently bad, but many times this loan program is sold as a new type of loan when in fact it is an option tied to standard loans, be it a fixed or adjustable rate mortgage (ARM). An interest-only loan is not a magic pill and misguided homebuyers shouldn't rely on unprecedented, unbridled home appreciation or increased wage earnings, commissions, or investment equity to satisfy the balloon principal after the interest-only mortgage reaches maturity.

In summary, most prospective homeowners should stick with standard fixed mortgages or ARMs. Generally, leave the interest-only loan option to the investment professional who has large assets and needs to leverage his assets to take advantage of other, higher money making instruments like equity investments.

First of all I would like to tell you that Interest-only mortgage loans are cheaper than any home equity loan. In this kind of loan borrower needs to pay the monthly principle and interest on loan for first 5 or 10 years only as per the loan company norms.