Understanding Interest Only Mortgage Loans
Interest only mortgage loans have both been vilified and idolized as incredible financial tools for buying a home. So how do they work, what are the real pros and cons, and is an interest only home loan right for you?
Interest only (IO) mortgage loans were incredibly popular in the early 2000s. They became scarce as mortgage markets tightened in the wake of the crisis, but began making a significant come back as the US housing market found its feet again. The Wall Street Journal has said that IO loans may be slightly more difficult to get approved for. However, access is expected to continue to get easier as home values rise, and mortgage lenders become more eager to make loans.
How Interest Only Mortgage Loans Work
Interest only home loans stand out for their lower monthly payments. In a nutshell, these loans allow the borrower buying a home to only pay the interest, resulting in a lower housing payment. Some have criticized these loans as bordering on being ‘exotic mortgages’. Others have found them to be amazing financial tools for buying a home, increased cash flow from rental investment properties, and building wealth.
An example of the potential monthly payment savings based upon a $250,000 loan for buying a home shows that the interest only payment would be just $833.34 per month. This is contrasted with a full regular P&I payment of $1,193.54. That’s a significant $360.20 less per month.
The Benefits of Interest Only Loans:
- Increase cash flow
- Increase yields on investment properties
- Get more home
- Get into homeownership earlier
- Increase velocity of wealth building and equity by investing the difference in higher yielding investments
The Potential Cons of Interest Only Loans:
- Interest only payments do not pay down the balance of your loan
- Higher payments later can put financial strain on some borrowers
- Still may need to qualify for a full P&I payment
- If other investments fail, borrowers may come up short
While interest only loans can offer a lot of flexibility, they generally only offer interest only options for a fixed period. This may often be 10 years. After this buyers will need to make both principal and interest payments that are high enough to satisfy the loan over the remaining 20 years. In this sense they are perhaps best suited to sophisticated home buyers, those planning to move within 10 years, or those anticipating increased earnings in the future.