What are loans that only pay interest? How are they set up, and who should use them? How can you avoid making common mistakes when choosing an interest-only loan?
Interest-only loans are loans where you can choose to pay only the interest each month. You can pay on the principal balance of these loans only when you want to or when it is convenient for you.
Most interest-only (IO) loans let you pay only the interest for a certain amount of time, usually between 5 and 10 years. At the end of the term, the rest of the principal amount is due.
If your income changes from month to month, an IO loan might be a good option for you.
But this part of IO loans can be a trap for people who don't have the discipline to pay on the principal even when they don't have to.
Borrowers who think their income will go up during the loan's term should look into loans with IO options. IO loans can also help first-time homebuyers who plan to move up soon from their starter home to a bigger one.
Another benefit of interest-only loans is that they require lower initial payments. This means that borrowers can qualify for larger loan amounts than with loans that don't have interest-only options.
Is your home going to be the most important investment you make, or do you want more money to put into other investments with higher returns? If you buy stocks or run your own business, an interest-only loan could be a good choice. Just make sure that the money you get back from your investments is more than the interest rate on your IO loan.
Do you plan to make money on the sale of your home during the term of the IO loan? Is the market where you want to buy going up quickly? If so, you might want to get a loan that only pays the interest.
There are risks with interest-only loans, and borrowers need to be aware of these risks if they want to use IO. What if your income doesn't go up as much as you thought it would? What if you can't sell your house for a profit in the future, or if the market doesn't go up as much as you thought it would? What will happen if the market goes down?
Some lenders are not honest, and when it comes to interest-only loans, they often trick people. Lenders often tell borrowers that the interest rate on an IO loan is lower than the interest rate on a loan with no interest-only option. This is a common lie. It's not like that. IO loans are riskier for the lender, so the interest rates are always higher.
Some dishonest lenders trick borrowers into thinking that if they choose an interest-only loan, they won't have to pay for mortgage insurance. Again, because IO loans are risky for the lender, the borrower is always required to have mortgage insurance.
The most important thing you can do to find the best loan for you is to compare different types of loans. Understanding how loans are set up will help you make the right choice for your situation. If you know what you want to achieve, you can find the right loan to help you get there.
