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Learn About Interest Rate Only Mortgages Before You Commit
Most mortgage payments are split into two when they reach the bank; a small portion reduces the equity, and the rest pays the interest. At least most mortgages work like this. Some banks have now introduced a new kind of loan to attract more customers by keeping the monthly mortgage as low as possible by only paying the interest.
The homeowner can pay whatever amount he wants, as long as he pays the minimum amount of the interest due each month. Of course, most lenders will allow you to pay more than the minimum interest payment any time you want, but that defeats the purpose of the loan, which is to keep the monthly payment as low as possible.
This loan had its place when home prices were escalating, since even if you never paid down some of your mortgage, you would still have plenty of equity because of the home's increased value. Normally, equity in a property is gained by a combination of paying off the loan value and increasing home values.
But the real estate market now cannot guarantee that you will earn equity in your home just by market increases. There may be some cases where interest only mortgages can work. This might be good option if it were a temporary situation.
One example could be when a two income couple temporarily only has one income, for instance if one of them went back to school. The assumption is that he will be in a position to pay more for mortgage once school is finished and therefore they will be able to make higher payments.
Another example may be where the homeowner has income that varies greatly from month to month. An example of this could be someone who performed project work and was only paid at the completion of each project. Keeping payments low in the months when income was low and then paying into equity when the windfall came would be a sensible decision, as long as the discipline was there to make the additional payments.
But eventually, the homeowner should be sure that those principle payments get caught up on. As mentioned, with "old fashioned" mortgages, the loan was paid down eventually because part of the monthly mortgage went towards principal, so the owner had some equity even if the value of the house did not go up. If the owner only pays interest, the loan balance never goes down, so if the owner sells in today's market of declining prices, he may not recuperate enough to pay off the mortgage.
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