6 Tips About Interest-Only Loans

See if this loan type is worth considering

1. What is an interest-only loan?

An interest-only loan is a loan where the borrower only pays the interest payment. When an interest-only payment is made, the principal balance on the loan will not change.

If you borrow $400,000 with a 6% interest only loan, you will pay $24,000 in interest payments for the year, but at the end of the year your loan balance will still be $400,000.

A regular loan usually involves paying both interest and paying down some of the principal over time.

2. How much can I save?

An interest-only payment is about 17% lower than a comparable fully amortizing loan with a 30 year term. Keep in mind that sometimes the interest rates on interest-only loans are slightly higher than regular loans, so this may affect your payment.

3. How long can I get an interest-only loan?

There are mortgages now that offer interest-only options for the first 10 years of the loan. Many other loans offer an interest-only option for other terms, such as 2, 3, or 5 years. One popular option currently is a 30 year fixed loan that is interest-only for the first 10 years.

4. Can I make extra payments to make up for this?

Check the terms of the loan. Some loans allow for an extra payment to be made, as long as the loan is not paid down too fast. Also check to see if the payment is applied to the principal, or is treated as a prepayment of the next month’s payment.

5. What are the drawbacks to this type of loan?

When you pay the interest-only level your loan size remains the same. Having a regular loan forces you to pay down the loan. In a sense a regular loan can be thought of as a forced savings account.

6. What if I want to build equity in my house?

Equity is built in two ways. The first is by paying down the mortgage on the property. The second is by the appreciating value of the home. Some people are satisfied with the annual appreciation of the property and have interest-only loans, allowing the increase in the value of the home to build their equity. The property may decline in value, in which case you are not building equity when you have an interest-only loan.