My First Loan

In the old fashioned mortgage mortgage market, you pay a part of your mortgage, and the monthly interest with each monthly mortgage payment you make. At least most mortgages work this way. But there exist now new kinds of mortgages that only pay the interest.

This means that if you pick an interest only option, each month you pay your mortgage, the loan balance stays exactly the same; it never goes down. Even with more conventional mortgages, you could pay extra on your mortgage to reduce the principal balance faster, but the idea of this loan is to keep the monthly payment low.

The concept was believed to be valid since rising real estate prices guaranteed an increase in the equity of the house. It used to be that homeowners built equity by paying down some of the loan, and by the additional value of the house.

However, changes in the real estate market mean that this type of increased value is no longer guaranteed, so any equity has to be built by paying off the principle. There may be some instances where interest only loans can work. This might be good option if it were a temporary situation.

One example may be when a two income family temporarily only has one income, for instance if one of them went back to school. This is a temporary situation, and as soon as the second partner finishes his studies and starts working, the loan should be switched to interest plus equity or additional payments should be made to lower the mortgage.

Another case might be that of a wage earner with erratic income that changes from one month to the next. Maybe a project worker is only paid at the end of a project. Keeping payments low in the months when income was low and then paying additional equity when the windfall came would make sense, as long as the discipline was there to make the extra payments.

In the current real estate environment, not building equity by paying down the loan is a dangerous solution. Using a traditional loan mechanism, if the property value is lower, flat or only increases slightly, the margin of equity that the homeowner deposited will cover the difference. However, if you always pick the interest only option, the mortgage principal will never be reduced, and the amount received by the sale of the house will not be enough to pay down the loan.

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Tags: Finance, Interest Only, Loan, Mortgage Broker, My First Loan, Personal Loans