The News on Interest Rate Only Home Loans
In the old fashioned mortgage loan market, you pay a part of your loan, and the monthly interest with each monthly mortgage payment you submit. At least, that?s how it used to work. Banks have now formulated a new type of loan titled interest only.
Basically the borrower can pay what he wants, as long as he covers the minimum of the interest payment. Even with more conventional mortgages, you could pay additional on your mortgage to pay down the principal balance faster, but the idea here is to keep the monthly payment low.
Interest only loans were predicated on the theory that it doesn?t matter that the principal was never reduced, because when the house was sold, the increased value would allow the borrower to pay off the loan. Normally, equity in a home is gained by a combination of paying off the principal and rising home values.
However, changes in the real estate market mean that this type of increased value is no longer guaranteed, so any equity has to be built by paying off the principle. The only reason that one would prefer to have an interest only loan is to keep the monthly payment as low as possible. But these situations should only be temporary situations.
A good example would be if one partner to the home loan was attending school and the other was employed. Since, in theory, the student would eventually complete his studies and get a good job, keeping the home loan payment low during this period and ramping them up later makes sense.
Or suppose a home owner has a sporadic type of income, in that he earns very little for a while and subsequently receives a large sum. Maybe a project consultant is only paid at the end of a project. Keeping payments low in the months when income was low and then paying into equity when the windfall came would make sense, as long as the discipline was there to make the additional payments.
But eventually, the borrower should be sure that those principle payments get caught up on. If you are paying off the principal a little at a time each month, when it comes time to sell the home, you earned some equity in it, even if home prices have not risen. If no equity has been paid down, the owner will have to find additional cash to pay off the mortgage if home values have not sufficiently improved.