Pros of interest-only loans
Flexibility: Interest-only loans offer you more choice in how you want to make your mortgage payments — you can stick with interest-only payments or choose to make additional principal payments during the interest-only period to reduce the principal balance and lower future monthly payments.
An interest only mortgage have lower monthly payments, as you only pay the interest and no downpayment. In those 20 years you would have saved as much as the entire mortgage in cheaper monthly payments. You can invest these savings and on average end up with more money then if you made downpayments on your mortgage.
With an interest-only loan, the borrower's regular payments include only interest, not the principal amount of the loan. A line of credit is a good example of an interest-only loan. Because there are no principal payments, the monthly servicing requirements are low.
Interest only can be a good option for investors, particularly if they are trying to cash flow and free up cash for other investments.
Disadvantages of an Interest-Only Mortgage
Interest-only mortgages are high risk - get it wrong and you can be stuck with an expensive loan that costs more than you get in return. If circumstances change before the term expires and these affect your ability to re-mortgage, things can get messy.
Interest-only repayments are available for a set period over the life of the loan. Up to 5 years on an Owner-occupied loan and 10 years on an Investment loan. Principal and interest repayments following an interest-only period will be higher than if you'd been paying both the principal and interest from the start.
To qualify for an interest-only mortgage loan, you'll likely need: A credit score above 700. A debt-to-income (DTI) ratio below 36% A down payment of at least 15% (depending on the lender)
Simple interest loans give borrowers the opportunity to save in interest, but as with any loan, making payments on time is important. If you make a late payment, you could end up paying more in interest, meaning a lesser portion will go toward your principal.
You can switch between Principal and Interest repayment and Interest Only payment options during the life of your loan. However, there are limits for how long you can have Interest Only periods. These limits apply when you request a new or extended Interest Only payment.
You have the option of making principal payments during your interest-only payment term, but once the interest-only period ends, both interest and principal payments are required. Keep in mind that the amount of time you have for repaying the principal is shorter than your overall loan term.
Advantages to Interest Only Loans
Tax Deductible – The interest you pay on a mortgage is a tax deduction which saves you money on your income taxes. Be sure to consult a licensed tax professional for any tax deductions you may be eligible for.
Short-term boost
This can free up cash flow for other expenses or investments. If you're experiencing a change in circumstances, paying interest only could make your loan more affordable in the short term.
Many lenders have strict interest-only mortgage criteria for residential properties, such as having a high income, a good credit score, or a large home deposit. However, you're less likely to qualify for an interest-only residential mortgage if you're a first-time buyer or in a lower income bracket.
Once the interest-only payments end, you will have higher payments for the interest plus principal. You can also refinance the loan or pay it off in full. However, since home prices fluctuate there is a risk that you might owe more on your loan than your house is worth.
No Equity Growth: Interest-only mortgages generally require large down payments, so lenders have collateral against default. But for the first 5-to-10 years, the homeowner's equity doesn't grow at all, unless you make extra payments. If your goal is paying down a mortgage, interest-only loans are a bad place to start.
Car loans, amortized monthly, and retailer installment loans, also calculated monthly, are examples of simple interest; as the loan balance dips with each monthly payment, so does the interest. Certificates of deposit (CDs) pay a specific amount in interest on a set date, representing simple interest.
Simple interest has the disadvantage that if the interest rate is high, the borrower will pay more. Furthermore, if the repayment period (years) is greater, the borrower will pay more.
0% APR auto loans are reserved for "well-qualified" buyers.
In most cases, "well-qualified" refers to borrowers with a credit score of 740 or higher. If a borrower isn't in this credit bracket and applies for the 0% APR offer, they could be taking a hit on their credit score that could have been avoided.
To qualify for an interest-only loan, you'll need: Proof of income, such as pay stubs and bank statements. The ability to handle larger payments once the initial interest-only period ends. A higher down payment, typically at least 15%, though this can vary.
A balloon payment on a mortgage is a large, one-time payment at the end of the loan term. If you have a mortgage with a balloon payment, your payments may be lower in the years before the balloon payment is due, but you could owe a big amount at the end of your loan.
Advantages of an interest-only mortgage
Lower monthly payments, as you are only paying back the interest on your loan. Greater control over your investments, meaning you can decide how you save to repay the capital of your mortgage.
There's a higher risk of negative equity than a repayment mortgage. The mortgage balance remains the same over the mortgage term, leaving you more exposed to changes in house prices. The total amount paid in interest over the life of an interest only mortgage will also exceed the interest paid on a repayment mortgage.
Can I make extra repayments with an interest-only home loan? Yes. Whether your home loan is on a fixed or variable rate, you can make extra repayments into the loan account.