Interest-only loans are mortgages in which the borrower pays only interest on the loan for a predetermined period. They’re popular among investors looking to purchase or refinance properties with higher cap rates, as well as those who have value-add projects or substantial renovations planned and need to save money in the short term.
When considering an interest-only loan, it’s essential to be aware of its pros and cons. These loans may not be suitable for everyone and they can come with additional risks. Before agreeing to take out an interest-only loan, here are the key things you should take into account:
Buying with Low Payments
Interest-only payments on loans can be much lower than conventional monthly payments, making them ideal for borrowers who need to conserve cash flow. Furthermore, loan repayments are more flexible if you have extra funds available to pay down debt sooner than planned.
Gaining More Home for Your Money
With an interest-only mortgage, you may qualify for a larger property because your payments are lower than with conventional financing. This could allow you to purchase a bigger house than what is affordable on conventional loans and increase the equity in your house – giving you greater options when refinancing or selling it later on.
Rising Housing Prices
In the late 2000s, speculative buyers often used interest-only loans to purchase property they couldn’t finance with traditional loans. While this strategy worked for some, those still owning their homes when the market crashed found themselves in difficult financial circumstances.
The primary disadvantage to interest-only loans is that they don’t create any equity in your home during the initial phase, meaning you cannot use them to help with a down payment or cover other expenses if you lose your job, are unable to make your mortgage payments, or for any reason other than lack of ability. This becomes particularly risky if mortgage rates rise and you no longer have access to funds to repay your interest-only loan – leaving you with less than what was originally paid for your home.
Tax Deduction
If you take out an interest-only loan that exceeds $1 million, the mortgage interest is tax deductible. This could save you money in taxes and allow more money to go into investments such as stock portfolios or retirement plans – a wise strategy if those assets grow rapidly.
Savings on Rent or Maintenance Costs
Interest-only loans may be an ideal solution for landlords who wish to reduce their overall rental expenses during construction. This strategy works particularly well in properties under construction or having significant renovations planned, as they usually produce low income during this time.
Another potential drawback of interest-only loans is their variable rates, which could make them more costly over time. Furthermore, when the interest-only period ends, you’ll have to start repaying both principal and interest – this can come as a shock for many people.
