What is an Interest-Only Loan and When Is It a Mistake?

Do you think that you need an interest-only loan? Are you even sure what it is? Because if you are, or if you’re not, then you need a little information before you dive right in and get an interest-only mortgage. There are a few things you have to understand about interest-only mortgages before you get one, so read up and pay attention.

An interest-only loan is one on which you may opt to pay only interest in a month, or you may pay principal as well. That means that if you pay interest and principal every month, as if it were a standard mortgage, then the loan would amortize at precisely the same rate as a standard mortgage of the same value. It also means if you only pay interest every month, then your loan balance remains unchanged. So if you got a $100,000 loan, and paid interest-only for ten years, then at the end of the ten years, you still have a $100,000 loan balance.

So there are a few things you need to clarify before you get an interest-only loan. First of all, can you make yourself pay on the principal when you don’t have to? Because if you can’t, you may not want to get an interest-only mortgage. It never forces you to pay principal-only interest. What you need to understand is that interest-only loans are not for people to buy a home they normally wouldn’t be able to afford, or for those who otherwise want more money for less cost-because in the end, an interest-only loan costs the same as a standard mortgage.

An interest-only loan is useful for two primary reasons. First of all, it’s useful for individuals with fluctuating incomes, because when money gets tight, it’s helpful when they have the option of not paying principal on the loan, but are able to pay it at other times. It’s also good for those who want to invest the money that they would normally use to pay the principal on a loan. Of course, the issue here is making sure that the return from the investment is greater than the interest on the mortgage-but if you can manage that, then it works well.

Another thing most people don’t know is that interest-only loans still need mortgage insurance. Sometimes lenders will insure the loan, but at a higher interest rate-so you need to be sure with your lender beforehand whether or not the loan is insured, and how.

So maybe now you’ll think again before getting an interest-only loan; if it’s still right for you, great! But if it’s not, or if you don’t think you could manage making “unnecessary” payments, now you know how to avoid a big mistake by getting a loan you can’t afford.