|  A
lot of information about interest-only loans has been flying around.
We give you a helping hand getting to the bottom of some of it.
Some financial writers have put a big warning sign
over interest-only loans; others have told people to dive right
in. Which is correct? The answer, of course, is that it depends.
A Realty Times article highlighted some key pieces of information
that consumers need to understand about interest-only loans in
order to know whether they are right for them.
With the topic of interest-only loans, it is prudent
to start with the conclusion: interest-only loans give the consumer
more options, which is always a good thing. However, just because
it is another option, that doesn’t mean it is a good option
for everyone.
The Basics
So what exactly is an interest-only loan? The basic premise of
an interest only loan is that, for a certain amount of time, typically
five years, all you pay in your mortgage payments is the interest.
You have the option to also pay some of the principal, but you
don’t have to.
The Bad Side
There are a number of downsides to any mortgage option; however,
the biggest problem that is particular to an interest-only loan
is as follows: once the interest-only term of the loan is complete,
not only are you faced with now paying a higher mortgage payment
because you are now paying principal as well as interest, but
your interest rate may also go up. This can hit some families
extremely hard, especially if your finances didn’t improve
as expected over the last few years.
The Good Side
The good news is that interest-only loans can make a lot of sense.
Because you can choose to pay principal as well, you can pay out
as much in principal as you would on a regular loan, but during
those couple of months out of the year that expenditures tend
to be higher than normal, you can cut out the principal portion
of your loan, just make payments on the interest, and not run
up a huge credit card bill! Another option is to invest the money
you would be paying on the principal into a higher interest savings
option. The best way to think about this is to consider your home
as an investment, with the rate of return on the investment (excluding
home appreciation) is the after-tax interest rate of your mortgage,
which, on a mortgage with an interest rate of 5.75%, roughly ends
up being a borrowing cost of 4.31%. There are many places that
can help you earn a higher return on your investment, which can
then be used to pay off a huge chunk of your mortgage, or can
be used for other investments.
The bottom line is that this is another option
in your arsenal. However, it is not an option to use if you are
relying on current house price rises to keep going, can barely
make the interest-only payments and are not able to put any money
down. Consider all your options with a mortgage specialist, and
come up with the best option for your unique situation.
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