"Interest only" loans are becoming increasingly popular and so it is important to understand
exactly how they work.
An "interest only loan" allows a person to pay a lower monthly
payment at the beginning of the loan in order to save money (or to anticipate
a larger salary) so that a higher monthly payment is more affordable later in
Scroll down for an example.
For this example, the Equity Calculator was used. Example:
A 30 year mortgage for $250,000 at 7% interest requires a monthly payment
For the "interest only" loan, using the calculator on this page we find that the monthly payment would be
$1,458.33 which is about 12.3% lower. Is this savings worth it?
Let's compare the mortgage to the "interest only" loan after five years have passed.
Look at the chart below.
Payment TotalInterest PaidEquity
Mortgage $99,795.37 $85,124.35 $14,671.03
Int Only Loan $87,500.00 $87,500.00 $ 0.00
So, after 5 years of "interest only loan" payments, you have the "advantage"
of "saving" $12,295.37 but you are left with 2 big drawbacks.
1) You have absolutely zero equity in your house. To put this in plain English, how
much of your house is actually yours? Absolutely nothing.
2) While you have enjoyed the 5 years of "saving" $12,295.37 you have also
lost five years that could have been used for earning equity in your home.
So now you have 2 choices.
1) Taking out a 30 year mortgage (which you could have done 5 years ago).
You'll be making payments on your house for a total of 35 years the
first 5 of which earned no equity and ended up costing $87,500.00.
2) If you don't want monthly payments for 35 years, you could take out a
7% 25 year mortgage and the monthly payments would be $1,766.95. That's
over a hundred dollars more than the
conventional 30 year mortgage.
So, you have lost 5 years and $87,500.