Greater Purchasing Power

One of the selling points of an interest-only loan is the greater purchasing power that it provides to the buyer. Because the buyer does not have to make payments on the principal of the loan, the lower monthly payments allow a buyer to qualify for a larger mortgage and therefore to qualify to buy more home.

For buyers who expect their earnings to increase during the life of their interest-only loan and who also expect inflation to increase the value of the property, using an interest-only loan to purchase property makes a great deal of sense, especially if the savings realized by getting an interest-only loan are fully invested.

Fannie Mae and Freddy Mac are the two main agencies which buy mortgages from banks and other lenders. Since lenders typically sell most, if not all of their loans to Freddy Mac or to Fannie Mae, they structure their loans to conform to the types of loans that Freddy Mac and Fannie May will buy. Right now, this means that many lenders are offering 30-year fixed rate loans with a 15-year interest only option.

That is why, for that for the first 15 years of a 30- year loan, the borrower has the option of only paying the interest portion of the loan. Borrowers who take advantage of this option will not be paying down the principal of their loan and will not be creating equity through principal reduction.

At the end of the 15-year interest-only option the borrower will need to either sell the property or the loan will convert to a fully-amortized 15-year loan. If the borrower allows the loan to convert to the fully-amortized 15-year loan then the monthly mortgage payments will be considerably higher than what the borrower has enjoyed for the previous 15 years.

It may be possible for the borrower to refinance the entire loan at the then-current rates and so keep his or her loan payments manageable.

Even borrowers who take advantage of the interest-only option and do not create equity by paying-down the principal of the loan can still expect to see an equity build-up after 15 years simply based on normal inflation and market pressures.