Interest Only Loans
Interest only loans are ‘interest centric’. In, this kind of loan a borrower only pays the interest due on the principal balance. In such cases, the principal balance does not change over the set term. After the expiry of the interest only term, the borrower has an option to go for the following:
The borrower can covert the existing loan to an amortized loan wherein he makes regular payments on the principal and the interest.
The borrower can also enter what is known as interest only mortgage, wherein he can make the payment on the principal amount.
The interest-only period varies from one country to another. In the United States, the interest-only period, typically, is for five or ten years. This essentially means that if a borrower has to pay a loan over a period of thirty years, he can only go for the interest-only option for the first five years or first ten years. This is dependant on the choice he/she makes and the money lending organization.
After the interest-only term is over the amortization of the principal balance takes place for the remaining years. The primary advantage of the interest-only loan is that the initial payments are much lower than the payment that a person makes later on. This enables borrowers to plan accordingly and they can borrow more amount of money than they can afford. This is done by taking into consideration the hope that. their salaries might just see a substantial increase over the term of the loan.
It can be said that when a person takes an interest-only mortgage (as in the US), the individual is paying the rent for the house. This is because there is no decrease in the amount of the principal loan. In countries like the United Kingdom, interest only loans are getting increasingly popular, as this is one way to buy any asset, whose price is not likely to depreciate much over time. If, at the end of the loan period a person is unable to pay the principal amount, the asset can be sold to repay the capital. Some countries allow a person to combine the interest-only loan with a myriad of financial options. This is illustrated by an example of Canada, which allows a combination of interest-only mortgage with options like corporate bonds etc.
While going for interest only loans, you must evaluate your options very carefully. As in the case of all loans, there are a few disadvantages as well. In many cases, you might have to pay property tax. In other cases, you have to buy property insurance that is a mandatory requirement when you take an interest-only loan. At times, a person has to pay a tax on his/her property and purchase the property insurance.