What is an Interest-Only Home Loan?
In case you're not familiar with it, an interest-only home loan (IO) is one that for the first several years of the loan term you only pay the finance charges as they come due. In other words, during this portion of the loan "repayment," the amount you owe to the lending institution stays the same as it was before you made your first payment.
Of course, after the IO payment term has expired, you will then need to convert the IO loan to a conventional PI mortgage, wherein you actually begin reducing the amount you owe to the mortgage company. And because you will be paying down the principal, the amount of your monthly mortgage payment will increase (is that something you want to look forward to?).
Looking at it another way, an IO home loan is a cleverly-devised home financing method that allows a real estate company to sell you more home than you can afford, while allowing the mortgage company to earn finance charges on higher loan balances that would not exist if home buyers only bought homes they could afford.
Ironically, the same mortgage company that accuses you of throwing money away by renting has no problem at all with you sending them pure finance charge payments that buys you absolutely nothing. I, for one wish they would call IO home loans what they really are, "Rent to Buy" offers.
How to Use Interest-Only Payments to Save a Fortune
Here is what I suggest to people who inquire about IO home loans.
First, calculate the IO loan payment using a calculator like the one on this page.
Next, determine the size of a conventional mortgage that would result in a PI payment equal to the IO payment (the interest-only home loan calculator will do that for you).
The result will be a house that will be more in line with what you can actually afford -- provided you have accurately forecasted the ongoing costs of owning the house (insurance, property taxes, utilities, maintenance, repairs, replacement costs, commute costs, etc.).
By reducing the size of the mortgage to allow you to make PI payments equal to the IO payment, at the end of the IO payment period, your mortgage payment will remain unchanged. This results in a monthly savings equal to the difference between the IO payment and the higher post-IO payment.
Furthermore, because you are buying a smaller, more affordable home, you will start saving money immediately in the form of reduced house ownership costs (insurance, property taxes, utilities, etc.).
So what can you do with all the money you'll be saving? You could ...
- Use it to your mortgage to pay it off early.
- Use it to pay off high APR debt.
- Invest it to earn interest on finance charge savings.
- Combine it with the equity you are building and trade-up to a bigger house without having to borrow more money.
The possibilities to save (earn) money using this idea are endless.