You thought you would be responsible, predictable. A nice conventional 30 year mortgage for you – fixed rate, real safe, nothing fancy, no adjustable rates. The trouble is, the monthly payment on such a loan for the house that is best for your family is beyond your budget. So your mortgage broker suggests an interest only loan. You want to know, what’s the catch?
An interest only loan can be a good financial tool to get you the property you need and want, especially in an aggressive housing market. The pace of the housing market has cooled somewhat, but in many areas prices are still rising and quality housing is in limited supply. If that describes the market you are buying into, the interest only loan may work for you, as long as you have a long range plan of what you really want to accomplish.
The danger of an interest only loan is that you are not paying principal. If you sell the house in a declining market, and have paid nothing toward principal, you may wind up owing more than the sale price of the house.
Make sure that you have a firm understanding in writing of what the interest rate is, and when it is subject to change. Some loans are tied to particular financial indexes, allowing for rates to rise and fall within a few percentage points of that index. Also, have an understanding in writing of when principal will be due, and if you can begin to pay principal earlier than you planned.
Interest only loans are very attractive for those buyers who anticipate staying in a home only a short time. In a rising market, you can build equity without paying any principal for the short term, and if the house prices dip, chances are the difference is not huge in a short time. If you are buying a property and improving it with the idea of selling it at a profit, an interest only loan may also work for you in the short term. Make sure you have a thorough understanding of the numbers involved.
Don’t take an interest only loan if you are looking to pay the same monthly payment for a fancier house, when one at a lower price will do. However, if the difference in price means a difference in neighborhood safety, schools, and quality of life for your family, an interest only loan may be the key unlocking a better life for you. Just be sure that you have a plan for paying down principal, and that you can really afford the home for the amount of time you intend to stay there.