Interest Only Home Loan Facts

An interest only home loan is a vehicle that allows borrowers to pay just the interest portion of their mortgage payment for a set amount of time before having to tackle both the interest payment and the balance.

Some investors consider interest only home loans risky, since borrowers don't get to build up equity in their homes during the first few years of owning them. However, there are two major benefits that have driven interest only investments hard over the past several years.

One of the benefits is that homeowners can own property and enjoy appreciation on that property without having to pay as much per month. For instance, if you buy a $800,000 house in Beverly Hills, and appreciation trends continue, you can bank on appreciation even if you don't generate equity in the home.

The other reason for the popularity of this instrument is that borrowers can afford more house for less. In competitive markets -- particularly markets in which property values have sky rocketed during the housing boom -- it sometimes makes more financial sense to go interest only than it does to “play it safe” with a mortgage that helps you build equity.

So what are the risks? If you don't budget wisely, or if you end up saddled by an unexpected debt or hit with credit troubles, you could be in trouble when it comes time to finance one to five years down the road. If you spend the first five years of a 30-year loan paying interest only, you then have to make the tough choice:

a) Pay off the full balance with interest of that loan over 25 years (instead of 30), or

b) refinance for an additional 30-year loan and have to eat the money you've already put down on the property.

In either case, you're losing money unless your house really appreciated in value.

That said, homebuyers with rising income streams enjoy this vehicle, since it allows them to live, in a sense, above their means, but not so far above that it risks their future. The trick is understanding your long-term costs before signing an interest only agreement. Not just your housing costs and attendant fees and penalties, but also your consumer debt and living expenses.