Interest Only Loans
Interest Only Loans - when and why?
With interest only loans, borrowers only pay the interest on the loan through monthly payments for a fixed term, 2-3 years. Because the borrower is only paying interest charges each month rather than interest and a portion of the principal, payments are lower than they would be with a traditional amortizing loan. Definitely a more unique way of borrowing money, and perhaps even a risky one. So why would someone choose to borrow money in this fashion, and when would it make sense for one to do so?
A Borrower Might Consider an Interest Only Loan if They:
- Expect to sell or refinance their property prior to the interest only period ending.
- Have income that heavily relies on bonuses or commission checks that come infrequently during the year and want the flexibility of making interest only payments during the times when their income is low and then paying more when their income increases.
- Are fairly certain they can get a significantly higher rate of return investing the money elsewhere.
- Expect to get significantly more income in the next few years.
Advantages of Interest Only Loans:
- A borrower can buy a more expensive property because less monthly income is tied up in principal payments.
- Interest only loans free up money – lower payments allow borrowers to choose where they put their money, whether that’s towards their principal, or in business or financial investments.
- During the interest-only period, the entire amount of the monthly payment typically qualifies as tax-deductible.
Disadvantages of Interest Only Loans:
- Many borrowers spend the extra money instead of investing it or can’t afford principal payments when the time arrives.
- Some borrowers aren’t disciplined enough to pay extra toward the principal. If you just pay interest, you’ll owe exactly the same amount of money in 10 years that you owe now – you’re just servicing a debt instead of paying it off.
- Income may not grow as quickly as planned and borrowers may struggle to make larger payments when the interest only period is up.
- Equity does not accumulate with an interest only loan without making extra payments.
When choosing an interest only loan, borrowers need a solid strategy for alternative uses for the money they’d otherwise pay towards the principal, as well as a strategy for getting rid of the debt. When this is the case, interest only loans tend to work well in favor of the borrower. Choosing an interest only loan for the sole purpose of buying a more expensive property or for the ease and appeal of putting off payments, though, is a risky approach and does not always pay off. If you need help determining if an interest only loan is for you, call us at (480) 835-5000 to speak with a specialist today!
Annie is a student at Brigham Young University, an entrepreneur, and an avid ice cream eater. She has happily been a team member at American Life Financial for two years now and loves learning about the ins and outs of real estate and lending, as well as the economics that affects the real estate market today.