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Interest Only Home Loans: The Pros and the Cons

Interest only home loans (also called option mortgage) are those that require only that the interest be paid monthly, instead of interest and a portion of the principal. Interest only home loans are attractive to a good deal of people when they need to finance the purchase of the home because the payments are substantially less, allowing them to save money and invest it someplace else, or simply have more cash flow.

Who an Interest Only Home Loan May Be Ideal For?

An interest only home loan is often ideal for individuals that only have seasonal work or whose work fluctuates from month to month or year to year. Many people that are just starting their own business and anticipate that their income will increase in the future will find that an interest only home loan will work well in their situation. Many savvy investors also find that interest only home loans are great because paying only the interest each month allows them to invest the money they are saving elsewhere so that they can pay their loan off in several lump sums while making a bit if capital for themselves. If you do not plan on living in your home for long you may also find that an interest only home loan will work out well for you.

If you have a seasonal type of job or your income is not steady an interest only home loan will allow you to pay the interest monthly, but when you have the extra cash you can pay more so that you are also able to dwindle down the principal as well. Seasonal jobs often do not allow people to comfortably pay their mortgage during the off season, but paying more during the busy season when they have more money makes more sense for them.

If you are smart with an interest loan you will invest the money that you save by paying just the interest and invest. You can make a lot of money off of the savings, and then when the time comes to pay off the principal of the loan, you will have also created a sizable nest egg for yourself. Many people find that when they invest smartly they can actually pay off the loan much sooner than anticipated.

Another great advantage in an interest only home loan is that it allows you to build credit. While you are only making small monthly payments, you are establishing more credit. Establishing more credit through an interest only home loan will allow you to take out automobile loans and the like much more easily than before. A loan is a loan, and it will always look good on paper when you make your payments as scheduled, even if they are just interest payments.

Who May Want to Consider a Different Type of Loan?

If you have a steady job, a family, and like the idea of building equity in your home, an interest only home loan is less than ideal for you. An interest only home loan does not pay off the principal of a loan as you go, so there is no equity built into your home as you pay. What this means is that if you are suddenly in need of large sums of money you couldn't get a home equity loan or sell your home for a profit because you have not put anything into the home. Many families consider their home a safety net, because if they get into trouble or there is a family emergency they can borrow against the home or even sell it for liquid money. If you have an interest only home loan you lose the safety net.

One serious disadvantage to the interest only home loan is that it has a substantially higher interest rate than other loan programs. Many lenders tell borrowers that the interest rate is the same or lower, but over time the interest rate is higher than a traditional loan program because it is riskier for the lender to extend an interest only home loan to a borrower.

Another thing that borrowers must consider is that the interest rate of an interest only home loan may increase substantially after the interest free period. This might not be an issue if you are able to make the payments, but the change in payments can often render the homeowner unable to pay, so that they end up defaulting on their loan. Investing the money during the interest free period is a great idea, but a good deal of people simply fail to do this, or they invest too aggressively and end up losing money. There is a very find line here, making the interest only home loan very costly and less than ideal for some people.

Final Thought

While an interest free loan may work for some, it can spell disaster for others. The most important part of the loan process is research and finding out what type of loan is best for you.



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