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Are Interest Only Loans Your Best Home Mortgage Choice?
By EchoBay Loans Staff Writer

A $250,000 home for less than $800 a month. Sound too good to be true? With the increasingly popular interest only home mortgage programs, many home buyers are being promised just that. Is it a scam? Not at all. Many long-standing, legitimate lending institutions are offering interest only home loans to consumers and brokers are beginning to promote these home loans more and more.

Contrary to popular belief, interest only loans aren't a new concept. This type of loan has been around for a while, but was usually only used by the more affluent home buyers. With the increasing popularity of this type of home loan, more consumers are becoming aware of the option and many people are tempted to jump right in without knowing very much about the details of such an arrangement.

As with any financial decision, when deciding whether or not an interest only home loan is right for you, you need to know enough about the details and specifics before making a final decision. The first step towards having enough information to make this decision is to know exactly what interest only loans are.

When you take out a typical home mortgage, you have a set monthly payment and each month a portion of that payment goes towards the interest on the loan and the other portion goes towards paying down the principal. When you take out an interest only loan, your entire payment is applied towards interest and you are not required to pay down the principal for the first few years of the loan. This results in an initially lower monthly home mortgage payment.

While this sounds great a surface value, and interest only loans can be a wonderful option in the right situation, there is much more to this finance method than meets the eye. The first thing that you need to understand is that the interest only portion of your loan is only going to last a few years. Once that time is up, you will either have to pay a huge balloon payment, a much higher monthly payment, or will have to refinance your loan.

If you don't think that the monthly payment amount will increase substantially after the interest only portion of the loan has ended, you need to reassess that line of thought. The increase in the monthly payment amount can be quite substantial, especially if interest rates rise. One of the major reasons for the increase in the monthly payment amount is the amortization factor. If your interest only period was for ten years, you will now be amortizing the balance of your mortgage over 20 years instead of 30. This will cause your monthly payment to be higher than if you would have opted for the traditional 30-year home mortgage to begin with.

For example, if you were to borrow $200,000 and were to opt for a traditional 30-year mortgage at 6 percent interest, your monthly payment amount would be approximately $1,200. If you were to borrow that same amount with the same interest rate on a 30-year interest only loan that has a ten-year interest only period, your initial payment for the first ten years would be approximately $1,000. However, when that ten-year period ended, even if your interest rate remained the same, your monthly payment would jump to almost $1,300.

While the above scenario can give you some idea as to the increase in the monthly payment that you may be faced with if deciding to opt for an interest only home mortgage, it does not take into account a rise in interest rates. Even if your interest rate were only to rise to 7 percent when it came time to amortize your loan, your monthly payment would jump to about $1,550. Unless you plan on being able to afford that monthly payment when the time comes, you're better off sticking with a traditional principal and interest mortgage plan.

Another thing to consider is that during the interest only period, unless your home is going up in value, you're not gaining equity in your property. Even worse, if your home goes down in value, you're going to owe more on your home than what you could sell it for. Many sellers receive the unpleasant surprise of being told that they'll need to bring cash to the closing table if they want to sell their home.

So does that mean that everyone should steer clear of interest only loans? No, there are times when interest only loans make sense. For instance, if you're a salesman or an executive whose primary income is from commissions or bonuses, then an interest only loan may give you the flexibility you need for your cash flow. When your bonus comes in or your commission check arrives, you can apply a portion to pay off a chunk of the principal of your mortgage. These loans are also great for people are making a lot less than they plan on making a few years from now. Interest only loans also make sense if the area you are moving to is experiencing steadily-increasing property values and you plan on selling the house within a few years of making the purchase.

An interest only loan is a great option for consumers that can take advantage of the benefits that this type of loan has to offer without risking any of the drawbacks. As long as you know where your payments will be when you take out the loan, where they will be when the interest only period ends, and you know for certain that you could afford both amounts, then you may want to consider opting for this mortgage product. However, if you're thinking about taking out an interest only loan because it's the only way you can afford the home that you want to buy, you should think twice and perhaps look for a home in a lower price range.

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