Leverage

Several years ago interest-only loans were marketed primarily to high-asset investors who were rather sophisticated in their investing and could make more money by putting the principal portion of their mortgage to work in the stock market or in another investment than they could by paying down the principal of their mortgage. Times and market conditions have changed.

Today, rising housing prices are forcing more and more average homebuyers into interest-only mortgages. An interest-only mortgage that saves a borrower $100 per month in mortgage payments can help qualify that borrower for up to $20,000 more house than the borrower could otherwise afford. A savings of $200 per month could leverage a buyer into a property that costs $40,000 more than he or she would otherwise have been qualified to own.

While there are risks involved in purchasing a property using an interest-only loan, many people are willing to take that risk, feeling that inflation and other factors that are forcing home prices higher will continue unabated into the future.

A buyer who leverages himself or herself into a higher-priced home using an interest-only mortgage is counting on his or her job to continue and they are counting on a continuing rise in the value of homes. Since an interest-only loan does not allow a borrower to build equity by paying down the principal of the loan, the interest-only borrower is counting on the various forces at work in the housing market to build equity for him or her.

If the housing market is strong at the time that the borrower must make the balloon principal payment then they buyer should be able to sell the property, pay off the principal and even show a profit – or the borrower should be able to refinance the loan.

However, if market conditions go against the borrower, then the borrower could lose everything and end up in a financial hole out of which it will be difficult to claw his or her way.