How to Understand Interest Only Home Loans

When you send in your monthly mortgage payment, part of it goes to pay the bank its interest, and part of it goes to pay down the loan. At least, that?s the way it used to work. A new type of loan has been designed to allow the monthly mortgage payment to be as low as possible, by requiring only the payment of interest.

The home owner can decide how much to pay each month, as long as he pays an enough to will satisfy the interest, and does not change the loan balance. 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 mortgage payment as low as possible.

The concept was believed to be a good one since rising real estate prices guaranteed an increase in the value of the house. The combination of increased equity due to market increases, and the paydown of the principle guaranteed most borrowers some residual value in the home when sold.

Today?s falling home prices means that homeowners can no longer depend on an automatic increase in their house?s value. There may be some cases where interest only loans can work. Today, it would actually only work if it were used as a stop gap device.

One example could be when a two income couple temporarily only has one income, for instance if one of them was going to school. The assumption is that he will be able to contribute to the mortgage once school is finished and therefore they will be able to make larger payments.

Another case may be that of a wage earner with sporadic income that changes from one month to the next. An example of this may be someone who performed project work and was only paid at the completion of each project. When income is low, the lower payment (interest only) option could be used and then when the windfall amount was in, higher payments could be made to pay down more of the principal.

But for any of these cases, the homeowners cannot count on the price of the home rising and should make sure principal payments are made. As mentioned, with ?old fashioned? home loans, the mortgage was paid down eventually because part of the monthly mortgage went towards principal, so the owner had some equity even when the value of the home did not go up. If you merely pay the interest each month, you will never reduce the principle, and if the home sales price is lower than the mortgage, you will not be able to pay down the loan.