Today, the terms ‘risky’ and ‘mortgage’ generally don’t appear together all that often. Burned by the recent four-year economic downturn, many homeowners are risk averse and desperate to avoid the high-risk, high-fee, and high probability of foreclosure loans that many banks have touted. It’s one of the end results of the world’s largest recession in recent history, and it’s biting buyers very hard.
But despite this, there is occasionally good reason to invest in loans that are risky, difficult, and a great deal less secure than their fixed-rate counterparts. From variable interest rate loans – called ‘adjustable rate’ mortgages by many – to loans that only ever cover the mortgage’s interest, many home and commercial property buyers today are looking at riskier loans than many other people.
Part of this is down to the recovering economy. With greater amounts of capital gained from investments in the stock market and equity markets, many buyers are prioritizing investments substantially more than they are property purchases. Likewise, with many jobs now paid on a performance basis, a number of workers are looking for mortgages that work with their income.
For these people, interest only home loans are a valid and fairly worthwhile idea. Unlike fixed-rate home loans, which require a constant series of repayments at a set interest rate, or variable rate and adjustable rate mortgages, which have a fixed rate period and a later amount of variable repayment rates, interest only home loans require the repayment only of the loan’s interest in its early stages.
The benefits of this type of loan are numerous, particularly for homeowners that would like to keep their initial payments on the low end. Just as an adjustable rate mortgage has an initial period of low interest rates – often fixed at a lower rate than the market – all interest only home loans require only the repayment of interest in their first few years. This means that borrowers never repay the loan’s balance in its initial period, allowing them to free up cash for short-term investments.
There are many situations in which this type of loan would be useful for borrowers. For people in a sales role, in which the primary form of compensation is a small salary bolstered by commission, it isn’t uncommon for income levels to be very unstable. One month could net a salesperson a modest income, while the next could bring a massive influx of short-term cash to their bank account.
In this case, the lower monthly repayments of an interest only home loan are beneficial. This is also true for business owners and entrepreneurs, both of whom need access to capital for investments or business-related purchases. With a fixed rate home loan to repay, their capital access could decline, hurting their business. With an interest only home loan, they can manage their business easily.
Finally, investors, particularly those that specialize in high-volume, short-term investments, need a source of short-term capital that’s dependable and isn’t compromised by other expenses. With high-level loan repayments to make, this isn’t a reality. However, with the minimal initial repayments of an interest only home loan, making large investments at a small earnings margin is possible.
However, despite the many advantages of this type of home loan, it certainly isn’t the best option for all borrowers. Just as adjustable rate mortgages were a disaster for some borrowers and a successful choice for others, interest only home loans can vary from good to bad depending on their borrower’s intentions. Many borrowers fail to understand interest only loans, and run into issues as it matures.
Look at any interest rate comparison chart and you’ll see that after the initial interest only period, an interest only loan’s monthly repayments swell to massive levels. A loan that requires only a modest monthly repayment of $1,000 in its early days can quickly grow into a $4,000 monthly monster at a later date, largely due to the growing presence of the loan’s balance alongside its interest payments.
This potential catch has caught out many borrowers, particularly those that invested in an interest only home loan without fully realizing how expensive it can be in the future. Despite this, loans of this type remain a competitive option for many people. This is because of their gradual growth – a non-issue for people that will experience salary and income growth throughout their career.
Finally, there’s a relatively strong temptation to use interest only home loans purely for their role in allowing borrowers to buy a larger home for their money. This is particularly common amongst the new homeowners of the world – people that are attempting to maximize their buying power, often at the expense of their long-term financial health.
If these downsides are avoided, or minimized by the benefits that an interest only home loan gives you as a borrower, an interest only home loan is a smart choice. However, it’s a choice that isn’t the ideal option for most people. Experts estimate that less than one percent of the population gets their best deal from an interest only home loan, and that most are better off with a fixed rate mortgage.
If you’re in that one percent, this type of loan is undoubtedly worth pursuing. However, if you fall into the same category as the bulk of the professional world – with a static income, limited overall investments, and no business to attend to – it’s generally best to look at another type of home loan.