An interest only loan can be a life saver for first time home buyers. For many in today’s struggling economy, going from a rental payment to a mortgage payment can sometimes be frightening. Conventional loan payments can be nearly double what renters were once paying which is why an interest only loan is oftentimes more appealing. Interest only payments help transition renters to home owners, by offering a lower mortgage payment during the early months of a loan.
With an interest only payment, the first five or ten years of payments go towards the interest only. Let’s say you purchase a home for $250,000 at an interest rate of 6.5%. For the first 10 years of a 30 year loan, you are going to pay roughly $1354. For the remaining twenty years of the loan the mortgage payment will go up to roughly $1863.
The reason these loans are risky for some is because of this drastic increase in payments after that initial period. The reason for the higher payments is that after those first ten years, you now have to pay towards the actual principal of the home. It is always advised that homeowners realize and understand this before accepting an interest only loan. While the lower payments may be nice in the beginning, home owners need to understand and budget for the time when the payment amount will go up. The nice thing about interest only payments though is that you can always pay towards the principal during the first ten years in order to pay off your mortgage faster.
One final thing to consider regarding interest only loans is that compared to traditional loans, the interest rate will be higher. Lenders increase the interest rate about of a percent in order to benefit from offering these types of loans.
In the end, it comes down to two things:
1) Can you afford a traditional mortgage payment?
2) Are the additional interest and higher payments in the end worth paying lower payments today?
Like stated, interest only loans can be a life saver as long as you understand the terms associated with them.