Interest-Only Loans: Advantages & Disadvantages?

Question

If you have personally taken out your home loan as Interest-Only or if you're on a business-level & you deal with interest-only loans, please detail Pro/con of this technique. I'm to stretch myself to max to purchase home with loan that would push $200,000 (my fiance & I only earn about $43,000 total income per year in a county where the average household is $70-73k/year).

Everyone said a clear "NO"! and
Everyone had great answers. In fact, so many were very thorough and convincing, that I can't vote on who gave the "BEST" vote, so I'm leaving it up to everyone to choose whom they feel did the best answer.
My sincere thanks to all - to go "Traditional".

Answer 1

Don't even think about it........There is no advantage to this kind of loan. You will have no equity in the home...plus you are paying outrageous interest, at the end of which you will have NOTHING. The lending institution will still own the house.
I can sympathize about not making a lot of money and wanting to own something. Start saving as much as you can...the cost of housing is going to come down in the next year. Try to get a 5 or 10% down payment and finance the rest. Try to find a small townhouse that you can afford.
Good luck!

Answer 2

Interest Only Questionnaire

In California we finance interest only loans all the time. Here are some additional questions to help you decide if this is the right decision for you:

- Are you planning on buying a home where the average appreciation is greater than 8%?
- Do you expect your incomes to increase to the county averages in the next few years?
- Do you plan on living in this home for less than 10 years before selling and moving?

If you answered yes to the above questions you may be a candidate for an interest only mortgage. Here are some pros and cons

--Cons--
-You are not paying down any principle.
-At some point the interest only period ends. Your loan payments will go up and you will need to refinance or pay the higher payment. (Generally after 5 or 10 years).
-If there is depreciation of home values in your area you will not have built any additional equity in your home and could be upside-down on your mortgage (You own more that the home is worth).

--Pros--
- Lower monthly payments
- Can afford more home
- Your tax write off doesn’t change from year to year. (All of your payments are interest) **Check with your tax advisor for your situation**

There may be other options as well. A 40 year mortgage can get the payments to about the same place as an interest only loan. You would have the stability of a fixed rate, it just takes a little longer to pay off.

You may qualify for Down Payment Assistance Programs (DAPs) offered by your state, county and city.

The most important thing is to make sure you are comfortable being able to make the mortgage payment. There is a payment you can afford and a payment the lender can qualify you for. If you are content eating Mac & Cheese and Top Roman then go with what the lender can qualify you for.

~Danke Schoen

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Answer 3

It really sounds like you're buying too much house for your income.

My advice is don't.

As to your question

Advantages:
Lower payments

Disadvantages:

Higher interest rates

They will start to amortize at some point, and the payment then will be higher than the principal and interest loan payment you couldn't afford when you got the loan. Jumps of 40% in the payment are not uncommon.

You're not paying down principal with the minimum payment. This means that your situation is only getting worse when you refi, if you refi, as you're likely to be rolling loan costs in to no good purpose.

Interest only loans are not completely awful. But unless you believe that your income will increase significantly before the adjustment, they are probably not a good idea.

Answer 4

Pro- lower payments, and some lenders will qualify you on some programs at the interest-only payment.
Cons- since you aren't paying off your loan, you aren't building equity unless home prices are rising in your area (which in many areas they are not)- if prices go down you may find yourself owing more on your home than it is worth. Since you're paying no interest, you get no tax deduction (assuming you qualify in the first place). When your interest-only payment period ends, your monthly payment will go up considerably.
Interest-only loans are good for some situations, such as (1) a property you know you are going to sell for a profit in the near future, (2) Income property where you are more concerned about immediate income as opposed to long-term appreciation, and (3) people who are sure their income will rise in time to stay on top of their fully amortized payments.
Unless your situation is one of the above or similar, I would not advise an interest-only loan for you.

Answer 5

First - Interest only loans are not for everyone.
With the threat of interest rate hikes looming over the nation, many people don't know what to do when their interest only (I/O) portion of the loan ends because their payments are so high. I/O loans are great for people that are trying to get into a home and can only afford a certain amount. But, also these same people have a foreseeable increase in their household income waiting on the horizon.

For example: If either spouse is finishing school or some sort of job advancement program, I/O loans are great because you anticipate a marked increase in income. Once your income settles in to its "normal" rate, most will refi IF they plan on staying in that home for a long time (20+ years).

Also, I/O loans are great for those that are just trying to get "in" and don't plan to stay long. For example: a recent single graduate purchases a home to live in and rents out the extra bedroom(s) to his buddy. Knowing that this is not the home he wants to spend the rest of his life in, he opts for a 5 yr I/O loan since he plans on moving before the 5 yrs is up. This example works for families with no kids, who don't plan on having kids for a few years, but wants to own a home to hopefully earn a little equity.

The main con of I/O loans is that in some areas the properties don't appreciate, but depreciate. If you get an I/O loan and your home value depreciates and you try to sell, you will end up owing $$$. Your only other option to losing $$$ is to just stay longer until the community rebounds and you gain more equity. For example: you purchase a home for $200K and only pay I/O for 5 years on a 5 yr I/O loan. Also, In that 5th year you have a Sept 11th happen to your community and the house depreciates, so your home is now worth $175K. Since you have only been paying the interest on your loan, the principal remains at $200K. So, even though the going rate for your home is $175K, you still owe the bank $200K because you didn't pay down the interest. If you decided to sell at this point, you would owe $25,000 to the bank. That's why many at this point would refi and wait it out little longer.

There is much more to say, but my hands are tired..........

Answer 6

This is a good way to go broke. An interest only loan means you are never paying off the principal. You will always have the same amount owing, ie 20 years from now you will still owe $200,000.

Just wait a little, the housing market is cooling. Money, or the lack of it is a good source of arguments between otherwise happy people.

Answer 7

No offense - but it sounds like you're digging yourself a nice hole. Why not just get something temporary for a while - a starter place or maybe renting for a while so you can save for a home.

Interest only - as far as I'm concerned is no advantage to the consumer and has a big advantage for the bank. It's just a 'tease' to have you move into a place you really can't afford.... and then you end up with huge bill problems....and stress.

It sounds like your young - so take it slow - you and your new wife will be happy wherever you are and you can 'grow' into your home as you go along.

No rush - I think back and didn't have a couch for my first 3 years of marriange. Sat on a mattress on the floor.....hardly owned anything (2 dishes, etc) and looking back, were some of my happiest days. You have a lifetime to 'get'. Today's society is tricked (by the media) into thinking that we need to have it all to start. You really don't..... start slow, be smart - your life will grow as you do.

Answer 8

As of late, more and more people are opting for “interest-only loans”. But they are actually only appropriate for a small group of borrowers. And in some cases, they can be the equivalent of “financial death”.

Since you asked to know the Pros and Cons, here's what I will gladly detail for you.

:• What is an interest-only mortgage?
• How to know if you are a candidate for an interest-only loan
• Common Interest-Only Loan Myths
• How to determine if you qualify for an interest-only loanWhat is an interest-only mortgage?

An interest-only mortgage is a special type of mortgage loan which allows you the option of only making payments on the interest each month. If you have an interest-only loan, you are not required to pay principal and interest every month, as you are with a traditional mortgage loan.You have the right to choose to only pay interest. Usually, the option to pay interest-only lasts for a specified period, usually 5 to 10 years.

WARNING: If you choose to pay only interest every month, you will never pay down your loan balance and your original loan amount will remain unpaid. (Example - if you obtain a $125,000 mortgage loan and pay only interest and no principal for the first 10 years, your loan balance will still be $125,000 at the end of year 10.)

How to Determine if an Interest-Only Loan is Right for YouThe first question you need to ask yourself is this:

“Am I disciplined enough to pay into a quality investment when I’m not required to?”
If the answer is no, an interest only loan may not be right for you.Many borrowers opt for an interest only loan to be able to afford a home they would not otherwise be able to afford with a traditional mortgage. We advise against this practice. Only purchase a home if you can afford to pay a full interest and principal payment every month. The consequences of purchasing more home than you can afford can be serious.An interest-only loan may be right for you if you have a fluctuating income and need the flexibility of paying interest-only when you are strapped for cash. Consultants and other professionals love interest-only loans for this reason.

Additionally, an interest-only loan is great for people who want to invest the money that would have otherwise been paid toward principal into a higher-yielding investment. For this to succeed, your return on investment must exceed the mortgage interest rate on your interest-only loan.

Common Interest-Only Loan Myths

Myth #1 – Interest only loans don’t require mortgage insuranceInterest-only loans having a down payment of 20% or less require mortgage insurance in many cases. Some interest only loans are insured by the lender as opposed to a traditional mortgage insurance company. This means that you will pay for the insurance, but it will come in the form of a slightly higher interest rate. Make sure you ask the lender if, and how, your loan is being insured...

Myth #2 – Interest-Only Loans amortize faster than regular loansclick here Interest-only loans amortize no faster than a traditional loan. As a matter of fact, while they are still in their “Interest-only” stage, an Interest-Only loan doesn’t even amortize at all! There is no magic connected to amortizing an interest-only loan.

Do YOU qualify for an Interest-Only Loan? Did you know that most people can easily qualify for an interest-only mortgage loan? Although the interest-only option is not available to everyone, it is unlikely you will be turned down for a mortgage altogether. Remember, mortgage lenders are in the business of saying YES.

May I suggest a link which offer some Free Online Calculators? This will allow to learn for yourself how much home you can truly afford.

http://www.freemortgageinformationsoutherncalifornia.com/calculators.aspx

Also make sure to check the local job growth forecast in the areas your looking to purchase and also the unemployment forecast.

Let me know if I can be of any further help.

Answer 9

There are some useful tips here.