What are Interest Only Loans?

Questions to ask lenders if you’re thinking of taking out an interest-only loan.

Interest only mortgages can be a great choice for the first time home buyer who may not have a large income, but predict that their income will increase over time. Essentially, an interest only mortgage pays off the interest only for the first few years of the loan. This term period can range anywhere from five to ten years, depending on the loan terms. During this time, absolutely no principal is applied to the mortgage, which can be disadvantageous to the home owner, as paying down principal means the mortgage will be paid off faster.

On the other hand, most loans allow the home owner to pay extra each month if they choose, which would go towards the principal amount of the loan. When shopping for interest only mortgages, be sure ask if there is something called a prepayment penalty for cases such as this. If not, you can pay down as much principal as you like each month.

There are several positive elements of an interest-only mortgage. The most obvious are the lower monthly payments. Initially on this type of loan, the borrower only pays the interest, which is much less expensive than paying interest and principal together. These types of loans are great for younger borrowers who are starting out their careers and predict that they will see a pay increase over time, and once the interest only period expires, they will be able to pay both principal and interest together.

The downside is that borrowers must be ready when the expiration period comes. Lenders should make home buyers aware of the projected new payments after the interest only time is up, so they can decide whether or not this loan type will be right for them. Enjoying lower house payments initially is the real bonus of an interest only loan, while the delay of principal repayment can be considered a negative. Weigh all of your options before deciding if this type of mortgage is right for you.