When you make your monthly home loan payment, part of it goes to pay the lender its interest, and part of it is used to pay off the loan. This was how all mortgages were until now. Some lenders have now introduced a new type of loan to attract more customers by keeping the monthly mortgage as low as possible by only paying the interest.
Basically the borrower can pay what he wants, as long as he covers the minimum of the interest payment. Just about all home loans allow you to pay off a higher balance than the minimum, and interest only loans are not different; you can pay more if you prefer.
The concept was believed to be a good one since rising housing prices guaranteed an increase in the equity of the home. Normally, equity in a home is gained by a combination of paying off the principal and increasing home values.
But the real estate market now does not mean that you will earn equity in your home just by market increases. There may be some cases where interest only loans can be beneficial. But these cases should only be temporary ones.
A good example would be if one partner to the home loan was attending school and the other was working. Theoretically, once the other partner completes school and starts working again, the mortgage payments can be increased to begin to reduce the loan.
Or perhaps a home owner has a sporadic type of income, where he earns very little for a while and subsequently receives a large sum. Maybe a project worker is only paid at the end of a project. While the project is ongoing, it is best to keep interest as low as possible, a need the interest only loan could meet, and then when income is realized, higher payments can be made.
But eventually, the borrower should make sure that those principle payments get caught up on. Using a traditional loan mechanism, if the property value is lower, flat or only increases slightly, the margin of equity that the borrower deposited will cover the difference. If no equity has been paid down, the owner will have to raise additional cash to pay off the mortgage if home values have not sufficiently increased.
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