What Is the Advantage of an Interest-Only Loan on Your House?
The interest-only loan has its pros and cons, just as any other type of financing. In order to take full advantage of this loan, the borrower must have a sense of responsibility and the ability to save and invest money wisely. In the right hands, the interest-only option allows you to use money otherwise spent on paying off the principle balance on other ventures that may yield a higher rate of return on the property's appreciation. This loan allows you to postpone the principle for five, 10 or 15 years down the road.
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History
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The interest-only mortgage was developed for wealthier and financially adept investors. This loan type allowed borrowers to deduct the full amount of their monthly mortgage payments, taking advantage of the tax breaks afforded to homeowners by the government, according to a New York Times article. Typically, the loans were "jumbo," or high, so the monthly savings were considerable. Knowledgeable investors then put that money toward other more profitable ventures and investments.
Where They Went Wrong
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In an article for Bankrate, J. David Lewis, a certified financial planner, says, "I can't see the average guy doing an interest-only mortgage because I can see him digging himself into a big trap." Skeptics of interest-only loans believe lenders were wrong to have presented these loans as a means of getting more house for the money. The benefits of interest-only loans assume that the borrower will make more money in the future, so they will be able to pay off the principle balance when the time comes. Irresponsible lenders, however, gave these loans to people who weren't in an upwardly mobile position.
Those Who Benefit
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There are a few borrowers who benefit from interest-only loans. People who are in high tax brackets need as many deductions as possible. Even if their loan balance is low and they could easily pay it off, having an interest-only mortgage is advantageous because they can write off the entire payment each month and use the savings to diversify their portfolios, according to CNN Money financial planner Tom Muldowney.
Self-employed, Commission and Bonuses
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Business owners and independant contractors have fluctuating incomes. In months in which they earn less, they can take advantage of the interest-only option on their loans. In months in which they earn more, they can pay down the principle balance as much as they'd like. This flexibility also helps those who are commissioned or receive bonuses at certain times of the year. They can pay down the principle balance when those larger checks come in.
House Hunters
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The interest-only loan helps buyers afford more expensive homes than they could get with a fully amortized loan. Lenders offer interest-only loans on both ends of the price spectrum. The difference between a principle and interest payment versus an interest-only payment, however, is most significant at higher loan amounts. It's important to consider how long you plan to live in the home, how much the home will appreciate while you own it, and whether you will be able to afford the mortgage once it adjusts to the principle and interest payment years down the road.
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References
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