Interest-Only Loans
Types of Loans
Repayment Types
An Interest-only loan is a loan in which the borrower pays only the interest for some or all of the term, with the principal balance unchanged during the interest-only period. Interest-only loans are often used for investment properties, as they can help to reduce the monthly payments and free up cash flow. However, interest-only loans can also be risky, as they can lead to higher interest costs over the life of the loan.
There are two main types of Interest-only loans:
- Traditional interest-only loans: These loans have a fixed interest rate and a fixed interest-only period. After the interest-only period ends, the borrower will begin to repay both principal and interest.
- Adjustable-rate interest-only loans (ARMs): These loans have an adjustable interest rate, which means that the interest rate can change over time. The interest-only period on an ARM is typically shorter than the term of the loan.
Interest-only loans can be a good option for borrowers who are looking to reduce their monthly payments. However, it is important to carefully consider the risks before you take out an interest-only loan.
Here are some of the pros and cons of interest-only loans:
Pros:
- Lower monthly payments: Interest-only loans can help to lower your monthly payments, which can free up cash flow for other expenses.
- Flexibility: Interest-only loans can provide you with more flexibility, as you can choose to repay the principal balance at any time.
- Tax benefits: Interest-only loans may be eligible for certain tax benefits, such as the mortgage interest deduction.
Cons:
- Higher interest costs: Interest-only loans typically have higher interest rates than traditional mortgages. This means that you will pay more interest over the life of the loan.
- Risk of default: Interest-only loans can increase your risk of default, as you are not building any equity in your home during the interest-only period.
- Negative amortization: If the interest on your interest-only loan exceeds your monthly payments, your loan balance can actually increase over time. This is called negative amortization.
If you are considering an interest-only loan, it is important to carefully consider the pros and cons before you make a decision. Interest-only loans can be a good option for some borrowers, but they are not right for everyone.
Things to consider before taking an Interest-only loan :
- Interest rate: Interest-only loans typically have higher interest rates than traditional mortgages.
- Risk of default: Interest-only loans can increase your risk of default, as you are not building any equity in your home during the interest-only period.
- Plan for repayment: Make sure you have a plan for paying off the loan, either by making extra payments or refinancing the loan.
- Shop around: Interest rates can vary from lender to lender, so it is important to shop around for the best interest rate.