Interest only loans may be the solution for you if you are looking for a way to afford more home for less money.
The Advantage of An Interest Only Mortgage:
An Interest Only mortgage is an excellent mortgage option for borrowers who want the lowest payment possible. An Interest Only loan means exactly what it says, the borrower pays interest only. By paying interest only on a mortgage loan, borrowers can purchase more home with the same payment as they would with a traditional 30-year fully amortizing loan.
How Do Interest Only Mortgage Loans Work?
An interest-only mortgage loan is very simple. For an agreed period of time (generally the early years of a mortgage when most of the payment goes toward interest anyway), your monthly payment will consist of only the interest due for that month. No portion of the payment goes toward paying down the principal balance. At the end of the interest-only period, your loan reverts to its original terms, with the monthly payments adjusted upward to reflect full amortization over the remaining years of the loan (for instance, following a five-year interest-only loan, a 30-year mortgage would now fully amortize over 25 years).
Why Should I Get an Interest Only Loan?
You won’t build equity in your home during the interest-only period, but it could help you afford to buy the home you want instead of settling for the home you can afford.
Since you’ll be qualified based on the interest-only payment and will likely refinance before the interest-only term expires anyway, it could be a way to effectively lease your dream home now and invest the principal portion of your payment elsewhere while realizing the tax advantages and appreciation that accompany homeownership.
What Are the Pros and Cons of this Type of Loan?
Cons. As previously mentioned, you will not build any equity in your home with this type of mortgage. Essentially, you are leasing your home indefinitely, or until there is a balloon payment, because you are not paying down the principal at all.
Also, after the completion of the initial interest only period, borrowers will be required to pay principal and interest, which may result in a significantly higher monthly payment.
Pros. However, for someone with an irregular income (perhaps a smaller base income with significant bonuses once or twice per year) this could be a very workable option. Another reason some borrowers prefer this loan type is when they know they will need to sell within a relatively short period (maybe 2 – 5 years). In this situation, having the least amount invested in the home may make the most sense.