- Interest only mortgage loans allow for the purchase of real estate with smaller monthly payments for a limited time. Instead of the monthly loan payments including principal and interest, the payments only include the interest. The principal portion of the payments is deferred to the end of the loan. When interest only payments are made, no equity in the property is being built. Eventually, usually after two to three years, the principal part gets added to the payments and thus the payments increase by a large amount. Interest only mortgage loans can be a smart choice in some situations and can be a poor decision that can lead to bankruptcy and foreclosure in other situations.
- Investors often use interest only mortgage loans when they only intend to own the property for a short period of time. The smaller payments allow them to minimize monthly expenses. Investors tend to use these loans during an inflating real estate market. Their gamble is that the property will increase in value so that they can sell the property for a profit before the principal gets added to the payments. Private home buyers often use interest only mortgage loans in order to allow them to afford a property that they could not afford if they had to pay for the principal. The smaller payments allow them to afford a more expensive house. An interest only loan is only a good idea if the purchaser will have a raise of income before the principal payments kick in. These loans are good for private buyers who know that they will have a raise of income or who can refinance the property for a better loan in a rising real estate market. Sometimes private buyers plan on refinancing the loan to a regular loan before the principal payments kick in.
- Both investors and private home purchasers can get themselves into trouble with interest only mortgage loans. Investors that rely on the property increasing in value, may find that their prediction was wrong. The property may either decrease in value or stay at the same value. If the property decreases in value, the investor will owe more on the loan than the property is worth. If the real estate market is slow moving, the property may take a long time to sell. The investor could be stuck with the increased monthly payments until the real estate market picks up. Private home buyers can get themselves into the same situation. If the property decreases in value they will not be able to refinance the property or sell the property. If they don't have a raise of income and they can't afford the payments, they may end up in foreclosure.
