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Interest Loan Only - Choosing an Interest Loan Only Option

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Interest loan only options are better known as interest only loans or interest only mortgages. Although interest loan only options have been unfairly blamed for the U.S. mortgage crises, this does not mean they are completely safe. These types of loans are not made for everyone and they have some risks depending on your specific situation.

Before you can determine if an interest only loan is right for you, it is first necessary to understand what, exactly, this type of mortgage is and how it works. An interest only loan is a mortgage where only the interest is paid on the loan for a fixed term before the principal balance is amortized according to the payment schedule. Many lenders in the U.S. push for potential homeowners to take out an interest loan only option for the first 5 to 10 years of the full mortgage term. This means that only interest is paid for the first 5 or 10 years before any of your payments goes against the balance.

The result of a loan set up with an interest only period is that you will have lower payments during the period of interest only payments. This allows borrowers to take out a larger loan than they would normally be able to. When a borrower does this, though, they are gambling that their income will rise over the course of the interest only period so that they will be able to afford the higher payments.

Now that you understand interest only loans, the dangers should be obvious. If the borrower’s income does not increase as much as initially expected, he or she could be stuck with a payment they cannot afford. This is supposed to be averted by a means test initiated by the lender, and it is this lack of adequate testing that led to the mortgage crises. Even though this testing is now more rigorously enforced, lenders consider interest only mortgages to carry more risk than other types of mortgages. Consequently, interest only loans have higher interest rates.

Interest only loans are really only acceptable to a select few borrowers. The person for whom an interest only loan is the best fit is someone who can currently afford the higher payments that are to come in the later years of the mortgage. This person can then use the extra money they have on hand due to the lower payments to make investments that could return them a higher rate than they are paying on the mortgage.

Financial experts should never recommend interest only loans to a regular wage-earning individual without an accompanying savings and investment plan.

Another type of individual for whom interest only loans can provide a benefit are those who make a large portion of their income from annual or biannual bonuses or commission payments. This allows them to have low monthly payments for the months between their large receipts. Then, when they receive their large checks, they can use any extra to pay down the principal balance in amounts they can afford.

Business owners may also find some benefit in an interest loan only option, because they often need to have an ample cash flow to keep their business running. Then, they can pay down the capital when their business has strong months.

If your situation does not match one of the above, an interest only loan cannot be recommended for you.

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