When to Consider Interest Only Home Loans

Interest only home loans have become common in our industry.  Although they are mainstream, many consumers do not understand how the loans work.  When is the right time to consider interest only home loans?

What Are Home Loans Interest Only?

Interest only mortgages offer the consumer the option to pay only the interest associated with the mortgae.  Normally, mortgage payments are calculated by using both interest and principal so the omission of the cost of the principal can be a signifcant savings. Typically, the interest only is for 5 to 10 years of the 30 year mortgage.  Once the 5 or 10 interest only terms lapses, the mortgage converts back into a principal plus interest monthly payment plan. Most consumers find the lower payment appealing and use the loan for additional cash.  The rates on these mortgages can be equal to or higher than traditional mortgage loans.

Who is the Home Loans Interest Only Right For?

There are several reasons to consider home loans interest only.  Reviewing loan terms helps.  For example, if you have a traditional 30 year fixed rate mortgage, during the first 6 years about 70% of your payment goes to interest.  With this type of loan, the typical principle payment can be invested in something with a rate of return that his higher than the borrowing rate.

Another thing to keep in mind is that, the average homeowner stays in their home for 5 to 7 years. If you are planning on living in your home for less than 10 years, the interest only loans can be a good choice because you can save the money for other purposes.  For example, if you invest the money from the principal you would have paid for the mortgage and apply it to an interest bearing account, and you live in the home for 7 years, you can build a substantial savings pool.  For example, a monthly payment is $2000.00 per month for interest only and $2800.00 for a regularly amortized loan.  The $800.00 can be saved for one year for a total of $9600.00 and if you live there for seven years, the savings will be $67,200.00- excluding any interest you may have earned. 

The Misconception of Home Loans Interest Only

One of the biggest misconceptions about the home loans interest only is that if you choose this option you are not paying down any of your loan’s principle each month and so you are not building home equity.  That is not always true. Historical data shows that homes appreciate in value on average 3% a year. So even if you do not pay toward the principle, you can still build equity.  Of course,  there are market considerations to keep in mind. When the housing market takes a tumble, so will your value and in that case, if you are not paying any principle you may find that your home loan may be higher than your home's value.

While home loans interest only are not for everyone, they can be a good option for some. It is up to each consumer to decide for themselves what works best for them.