Facts on Interest-only loan
Interest only loans, as the name implies would enable borrowers to pay the interest alone. In the case of a standard loan repayment schedule, the borrower would have to pay a monthly repayment amount which would consist of two parts, one is the interest and the other would be a part of the principal amount. But, in the case of interest-only loan, the borrower’s monthly payment would consist of the interest amount alone.
Borrowers opt for interest-only loans for a variety of reasons. Certain borrowers would love to buy a luxurious home for them and eventually pay a lower monthly repayment amount. Borrowers can spend more money than those who opt for other loans. Interest-only loans are best suited for people who have a variable income.
Borrowers who have a commission-based income or a variable income wherein their salary would rise and fall with respect to time can opt for interest only loans, since they need not carry the burden of paying higher monthly amounts when they earn lesser amount as income. Once they get to a better financial situation, they can pay out the principal amount of the loan.
Borrowers have to save the money for the loan principal payment when they still pay for the interests on a monthly basis. Borrowers have the advantage of customizing their repayment amortization schedule.
The main drawback of interest only loan is that the borrower would not be able to generate any wealth from his or her home. If the home, which was kept as a security to avail the loan, loses its market value, then the borrower might be forced to sell it. The loan principal amount should be paid back to the lender sooner or later.
For example, if the market value of the home at the point of availing the loan is $500,000. If the borrower has availed an interest only loan for 80% of the market value of the home i.e. $400,000 has been availed as the interest only loan, which is the principal loan amount.
Borrower would pay the monthly interest, but this particular debt of $400,000 would stay as it is until the borrower pays it back. Suppose, if the market value of the home falls to say, $460,000, then the borrower would not be able to get back his or her full down payment of $100,000 back. If the market price drops even below $460,000, then the borrower would end up paying the loan from his own pocket.