Interest-Only Mortgage Loans

This type of loan allows you to pay the interest only level, rather than the regular larger amount that will pay off the loan over time. Paying at an interest-only level keeps the loan balance or principal the same.

There are two ways to build equity in your property. One is through the rise in property value, and the other is by paying down your loan. Some borrowers decide to take interest-only loans and let a possible rise in property values build equity for them.

The time frame for making interest-only payments is usually limited. There are no 40 year interest-only loans available yet for home mortgages! At some point, the loan needs to start being paid off.

Building equity

Some people take a regular loan that includes paying down the loan because it is a form of “forced savings”. This is a disciplined monthly payment that allows them to salt away savings over time in the form of equity in their property. Of course, if you buy a house with 100% financing and the property starts declining in value, then you may be paying down the loan but there is little or no equity being built.

Interest-only initial period

Many loans offer an initial period in which interest only payments are allowed. An interest only payment period may last from several years to even 10 years. A particularly popular loan program now is the 30 year fixed loan, with a 10 year interest-only option. This gives the borrower the security of a 30 year fixed loan, with the convenience of being able to make lower interest-only payments over the first ten years.

Some interest only loans allow you to pay more each month if you choose to. Check the details of the loan to see if this is an option.

Other alternatives

For people looking to get a lower payment, there are also other options.

One option is to stretch the loan term. Instead of a 30 year loan term, you can get a lower payment by switching to a 40 year term.

Another option is the “minimum payment option” or “option ARM” loans. These are loans that allow a borrower to pay less than interest-only for an initial period of time.

Example

A 1% minimum option loan can have four different payment levels:

• the minimum payment of $1,287

• an interest-only payment of $1,649

• a 30 year payment of $2,134

• or a 15 year payment of $3,152

This is a basic summary of this loan type. It can lead to negative amortization, where the principal balance of the loan actually increases over time. This is an option to consider only after you understand how the loan works.