Interest-only Loans – What are They and are They for You

A loan is said to be interest-only if the monthly instalment payment that has to be made by the borrower consists of only the interest. The luxury of paying the interest lasts only for a specific period of time though, which normally ranges from five to ten years. The borrowers though have the option of paying more than the interest if they want to. In an interest only loan the loan balance will remain as it is. For instance, for a loan of $100,000 over a 30-year period with an interest rate of 6.25 percent, the borrower will have to pay an amount of just $520.83, in case of an interest-only loan. However, for a loan without an IO option, the borrower would have to pay a total of $615.72. The difference here in the amount is the principal.

Type of borrowers for whom an interest-only loan is suitable

An interest-only loan is availed by only those borrowers who have a valid reason for taking the lower initial payment and are also ready to face the consequences in future. Here are some examples:

  • People who would like to pay the principal amount when convenient

The borrowers who do not have a stable income would like to have the flexibility that comes with an IO mortgage. As when their financial condition improves, they can make that substantial payment to principal.

  • People who are looking for a new house

Many families have the habit of beginning with a small house and then moving to a bigger house as their income increases. Such trading up includes lot of moving and transaction costs. However, with an IO mortgage, you can upgrade to a bigger house immediately.

  • Payment responsive to principal reduction

Many people find it convenient when the mortgage payment declines the month following an extra payment. This feature is available only with IO loans. It is very popular with people who have bought a new home and must settle the loan before selling their existing house.

  • People who want to allocate their cash flow to a second mortgage

IO mortgage also gives a lot of flexibility to people who need to pay urgently towards their second mortgage and are short of required funds currently.

  • People who are looking for a quick capital gain

An interest only loan is a perfect choice for people who are trying to increase the amount of house they can buy, but are left with no choice because of their limited income.

What to be careful of?

You have to be very careful though when accepting an interest-only mortgages as many such mortgage do not come with the various features explained above. The other aspect is the presence of a lot of deceptions. Here are some of the deceptions –

  • Lenders charging a higher rate for a loan with an IO option.
  • Some lenders say that it is cheaper to amortize an interest-only loan.
  • Lenders quoting an interest rate which is fixed for the interest-only period, but it might not be entirely fixed.
  • Lenders assuring the borrowers that they won’t have to pay for the mortgage insurance in an interest-only loan.

However, if you take all the right precautions, by consulting a mortgage broker or a loan officer who you can trust and who is willing to provide you with all the essential data on the features of each loan, you will have all your issues resolved.