When you pay your monthly mortgage payment, you may have noticed that a part of it (however small) decreases the mortgage and the rest of it pays the interest. This was how all mortgages were until now. Some banks have now introduced a new type of loan to attract more customers by keeping the monthly payment as low as possible by only paying the interest.
The home owner can decide how much to pay each month, as long as he pays an enough to will satisfy the interest, and does not change the loan balance. Just about all mortgages allow you to pay down a higher balance than the minimum, and interest only loans are not different; you can pay more if you prefer.
There may have been some reason for this kind of loan when home prices were increasing drastically, since the borrower would be guaranteed some equity due to the increased home price. Equity was built by a combination of mortgage paydown and increased home values.
Today?s falling housing market means that borrowers can no longer depend on an automatic increase in their house?s value. There may be some instances where interest only mortgages can work. But these situations should only be temporary situations.
A good example would be if one partner to the home loan was attending school and the other was working. Since, in theory, the student would eventually complete school and get a good job, keeping the mortgage payment low during this period and ramping them up afterwards makes sense.
Or perhaps a home owner has a erratic type of income, where he earns very little for a while and subsequently receives a large payment. Such an example may be a project worker who is only paid when the project is complete. 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 comes in, higher payments can be made.
But for any of these cases, the homeowners cannot count on the value of the home rising and has to make sure principal payments are made. If you are paying off the loan balance a little at a time each month, when it comes time to sell the home, you will have some equity in it, even if housing prices have not risen. If the owner only pays interest, the mortgage balance never decreases, so if the owner sells in today?s market of falling prices, he may not recuperate enough to pay down the mortgage.
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