Learn About Interest Rate Only Mortgages Before You Commit
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 most mortgages work this way. But there are now new kinds of mortgages that only pay the interest.
The homeowner can pay whatever amount he prefers, as long as he pays the minimum payment of the interest due each time. In most home loans, you have a choice to pay more than the fixed loan payment, but the difference is that the interest only mortgage will keep the monthly payment as low as possible.
Interest only loans were predicated on the theory that it doesn't matter that the loan was never reduced, because when the home was sold, the additional value would allow the borrower to pay off the loan. The combination of increased equity because of market increases, and the paydown of the principle guaranteed most borrowers some residual value in the house when sold.
Now that home values are falling rather than rising, the validity of interest only loans has been called into question. There are cases where interest only loans are a good idea. But it should really only be used as a temporary solution.
One example may be when a two income family temporarily only has one income, for instance if one of them went back 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 valid situation might be if the primary income owner had an erratic earning pattern, in which he had little to no earnings for a period and then a windfall income. Maybe a project worker is only paid at the end of the project. Keeping the mortgage low in the months when income was low and then paying additional equity when the windfall came would make sense, as long as the discipline was there to make the extra payments.
In the current housing environment, not building equity by paying down the loan could be a dangerous situation. You want to make sure that you pay down some of the principle so that you will have some equity put in the home, since you can no longer count on housing market increases to do so. If the owner only pays interest, the loan balance never decreases, so if the owner sells in today's market of falling prices, he may not recuperate enough to pay down the mortgage.
by: Arlene K. Monaghan
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