Since you've been discussing loans, could someone explain how "Interest Only" loans work? What are advantages and disadvantages of getting this kind of loan? I know more and more people who are doing it and would like to find out if it's worth it in a long run.

 

You can purchase a more expensive home then you could otherwise afford. You won't be putting anything towards principal, so only swings in the market will effect your appreciation. Some people get interest only loans to minimize payments but then pay off principal at their own rate with separate payments.

I have not looked into these, but I suspect negative amortization also can come into play with these. This is where your payment is capped below the real interest rates and the principal that you owe actually goes up.

Supposedly this is a good loan for those that will be in the home for a very short period (just a few years), or those that are diligent enough to add their own principal payments to the monthly payments. To me these seem a bit more risky, but I tend to be somewhat conservative financially.

 

Interest only loan works in the following manner:

Your rate is fixed for the first 3, 5, 7, 10 generally, payment is based on 30 year payout. You can also get 1,3,6, 12 month, but more risky.

Your payment is only the interest on the loan, you can choose to pre-pay the principal. It's a good way to have a flexible monthly payment. With us for example, when you make a payment towards principal, payment adjusts lower (re-amortizes itself every month).

The negative side is that if you only make the IO payment, you will not pay the loan off and will be banking on the fact that property will go up in value. If house prices plunge, you will be upside down. Generally speaking however, these are very good loans but you have to be disciplined to pay down the principal. These loans are better for people that are planning to stay in the house for shorter periods of time.


Hope this helps a bit.

 

I didn't know that.

I still don't think I'd be disciplined enough to do this responsibly.

 

I'm in an interest-only loan right now.

Advantages: lower payments, or the ability to buy a more expensive house.

Disadvantages: principal doesn't get paid down; higher interest rate, usually 1/4 percentage point; risk of housing plunge, in which case your loan will be more than the value of your house -- not a big risk if you're in a hot housing market.

The reason I did interest only is because I purchased my house with a friend of mine, making our house a short-term investment. If you look at an amortization table, you'll see that in the first few years, nearly your entire mortgage payment goes toward interest. So in my case, it didn't make much sense to go with an amortized loan. My friend and I are planning on paying a little extra each month since we just refianced, and our payment is really low -- less than $800 for each of us per month.

 

Or in my case, Using an IO as a construction loan while still linving in current home. This minimizes the overall pmt for both loans, and the IO is convertable via a refi to a trad mort at the end of the IO period.