Why the New Interest in Interest-Only?

An interest-only mortgage means your monthly payments cover only the interest on the loan. They do not pay off the amount you owe. So, at the end of the mortgage term, assuming you have made all the interest payments, you will owe the same amount that you borrowed at the beginning. You need to have a lump sum available to pay the mortgage back in one go at this time. Make sure you make arrangements to pay off the loan when the mortgage ends. If you don't, you could lose your home.

An interest-only mortgage might be a good fit for: someone whose income is mostly in the form of infrequent commissions or bonuses; someone who expects to earn a lot more in a few years; someone who truly will invest the savings on the difference between an interest-only mortgage and an amortizing mortgage, and who is confident that the investments will make money.

When you go too far down-market, interest-only loans don't save enough money to be worthwhile. Let's say you borrowed $200,000 at 7 percent. For the first three years, the savings from an interest-only loan would amount to less than $200 each month. Double the loan amount to $400,000 at 7 percent, and an interest-only loan saves more than $325 in the first month. The advantage of an interest only mortgage loan is that it allows a borrower to free up capital to invest in assets that yield the highest return, or serve some particular financial-planning purpose, rather than locking it up in a house. For example, you could take the money you'd be paying in principal each month and:

1. Pay down more expensive debt such as credit cards.
2. Set it aside to help pay for a child's college fund.
3. Invest it in the stock market over the long haul.
4. Invest more in your employer's matching 401(k) contribution plan.

In the above scenarios, you won't have paid down your mortgage at all, but your financial picture outside your mortgage will be much more robust. Surely, there are plenty of pitfalls in not paying down your principal. For one thing, you'll be building up less equity in your home. On the other hand the amount of equity you build by paying a full payment is very minimal for the first 10 years of a 30 year fixed rate mortgage as you are paying almost 85% in interest to the bank. You have to also consider that you most likely will be accumulating equity as the property appreciates in value over the interest only period. But if you think you live in a market where prices aren't likely to rise much, or might fall, you might want to use the option to pay down some of the principal to give yourself an extra cushion of equity.