First Time Home Buyer – Pros and Cons of Interest-Only Loans

A typical loan includes monthly payments that are applied to your loan balance and your interest costs. Over the term of the loan, your payment is designed to keep up with that interest while gradually paying off your debt. When you have an interest-only loan, you are paying just the interest, not the actual principal portion of the loan. The result is a lower monthly payment for a certain amount of time. It’s expected that you’ll eventually pay off the loan with higher monthly payments or all at once.

What are the Pros of an Interest-Only Loan?

There are a number of benefits that come from setting up an interest-only loan. If you plan accordingly, you can use this loan option to make a smart investment in a home.

You Can Purchase a Higher Priced Home

When you first apply for a loan, a lender will determine how much you can borrow. This amount is typically based off of your monthly income compared to what your monthly debt includes (car payment, utilities, cell phone bill, childcare, etc.). Your monthly debt amount will take into account your upcoming mortgage payment. When you have a lower payment on an interest-only loan, the amount that you’re allowed to borrow will increase quite a bit. However, you need to be sure that you’ll be able to afford the house you’re considering buying, taking into account any unexpected expenses that may come up in the future.

Money Flexibility

When you have a lower monthly payment, this provides you with flexibility regarding the money that you have coming in each month. That extra cash can go towards your mortgage, it can be put into savings, you can invest it, etc.

Keeping Your Living Expenses Down

An interest-only loan can be something that people can afford, whereas they wouldn’t be able to afford a standard mortgage. Owning a home is a much better investment that paying rent each month. As long as you have reliable income coming in each month, this may be a loan option that you should talk to your lender about. Keeping your monthly dues low while putting money into other large payments when you have them will lower your principal amount over time. If you need the extra cash on any given month, it will be available to you.

What are the Cons of an Interest-Only Loan?

While an interest-only loan may be beneficial for some people, there are cons that could impact your decision-making process. Let’s take a look.

You Don’t Build Equity

An interest-only loan doesn’t provide you with the opportunity to build equity in your home. Equity is important if you ever want to sell your home or use your home for a loan. If you don’t have equity, you might be turned down for a home equity loan or line of credit.

Losing Value

It’s possible for your home to lose value after you have purchased it. You might end up owing more on the home than you would sell it for. This puts you underwater, and you would have to cut a check to the bank once the home is sold.

Accruing Additional Interest

If you finish paying out your interest-only payments but end up discovering that your loan has generated more interest in that period of time, this unpaid interest will get added to your loan balance. The amount of your mortgage will turn out to be higher than what you first thought you were borrowing.

Temporary Loan Option

Keep in mind, the interest-only portion of your loan will only apply for a few years. It doesn’t remove the need for you to pay back your loan amount at some point in time. If your monthly payments are only covering the interest of your loan, you might owe the same amount of money in ten years as you do right now. A lot of people choose to refinance their mortgage eventually because of this situation.

There are numerous pros and cons associated with an interest-only loan, and you should speak with a lender to figure out what the best option is for your specific financial situation. There are many cases where people are using this type of loan option for the wrong reasons, which makes the cons stand out more than the pros most of the time. If you have a legitimate plan that benefits from an interest-only loan, you can set yourself up for success. If you would like more information on an interest-only loan, feel free to reach out to ken@capitolmortgagegroup.com or call (804) 362-7600.