Interest Only Loans

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Interest-Only Loans: An Interesting Prospect

Home loan financing has been getting very creative in the past few years, and the trend continues today. One of the more popular new mortgage products on the market is the interest-only mortgage loan. But before you chose an interest-only loan, take a moment to learn its pros and the cons.

What is an interest-only loan?

Interest-only loans are home mortgage loans in which only the interest is paid on the loan for the first 10 years. After that, the mortgage loan becomes fully amortized, which means you pay a monthly principal payment as well as the interest payment.

What are the benefits of interest-only loans?

Like many of the mortgage programs developed in the past few years, interest-only loans were designed to allow more people to get into the housing market. For example, a $400,000 first mortgage at a 6.25% interest rate has a principal and interest payment of $2,463 per month. The same interest rate of 6.25%, with an interest-only payment, is $2,083 per month, a $380 per month savings. This lower payment amount can help more borrowers qualify for a home loan, as well as allowing other homebuyers to purchase a more expensive house.

What are the downsides of interest-only loans?

While the interest rate is fixed throughout the duration of the loan, the payment is not. After 10 years, your interest-only loan will become fully amortized--at which point you'll have 20, not 30, years to pay off your principal. Using our example above, after 10 years of mortgage payments, you still have a balance of $400.000. To pay the mortgage off in 20 years, the principal and interest payment demands $2,924 per month--almost $850 more than the original interest-only payment. This is manageable for some owners, especially if they are on a strong career track, but for other borrowers this is too much of a rate hike.

Talk to a real estate professional or mortgage lender to see if an interest-only loan is right for you.

Sheryl Landrum, Senior Loan Officer, First Capital Mortgage of San Diego, Bonsall, CA.
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