INTEREST ONLY in Interest Only Loans

I had scarcely heard about Interest Only loans in the early 2000’s until around 2004 or 2005 when it seemed that and the Option Arm were the only alternatives when it came to purchase or refinance loans.

The first two firms I worked for did not offer the loans and it was not a big deal as there was not much demand for them. Then late 2004 nearly every borrower knew what they were and was interested in them for their refinance or purchase loan.

Individuals who have interest only loans have the option of paying more of course but they are only required to pay the interest payment. During the interest only period the balance of the loan never changes. One thing to remember, and some forget this, most I/O (interest only) loans are interest only for only 5-10 years of the loan then the fully amortized payment is due each month.

A nice thing about an I/O loan is it gives you the flexibility to pay the fully amortized payment, then if you have tough month, maybe you had unexplained expenses come up, you can then just make the interest payment. If borrowers take this approach the loan is a pretty good deal. The only problem here is that most are not disciplined enough to make a fully amortized payment when it is not due. Then ten years later they lose the option to pay interest only and their payment shoots up because the house has not been paid down and they are paying principal and interest. This sudden financial stress could be disastrous.

When most people go to buy their first home it is viewed as the starter house. The one that they will keep until their income goes up enough to afford the house they really want. That costs quite a bit to do that but with an interest only loan they can buy more house the first time and get the home they really want and that saves them the expenses of doing two loans.

Some people use the excess cash flow to build wealth in the stock market, but one has to have the discipline to do that and to not just spend the money on other things. Some will use the extra cash flow to pay off a higher interest second loan. That is a wise use of an interest only loan.

If you are planning on selling the home you just bought for a quick profit, and you are in a location where home values are steadily appreciating, you will want to make the lowest payment possible which will be an I/O loan or the lowest payment on an Option ARM loan. Since you are selling the house for a quick profit it is not necessary to try to pay down the principal.

To be safe and in a perfect world borrowers would make sure they could afford to pay the fully amortized payment before buying the house. That way they can afford the payment after the I/O period. They will also be able to make their payments when the home has lost value and refinancing or selling are no longer an option.

Put some thought into this type of loan. My buddy refinanced his home to an interest only option and five years later had to walk away from the home. You don’t want to go through that kind of pain.

Good luck and happy borrowing.