Considering an Interest-Only Loan?

So, you’re considering an interest-only loan? With proper planning, this could be the best decision you ever make. However, without a realistic strategy to pay down the principal it could also become your worst error.

For those of you who are unfamiliar with the interest-only loan, allow me to explain. This type of loan is non-amortizing - designed to allow more flexibility in repayments than an average loan. For the first several years of the life of the loan (usually 5-7 years) the borrower need only repay the interest accrued on the loan. After this time they can either pay off the loan in one lump sum, refinance or start paying down the principal like a regular loan.

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The interest-only loan can be especially appealing to borrowers who bring in much of their income from large, irregular bonus payments. Because their monthly salary may not be all that high, they would prefer to keep the regular repayments as low as possible. When that big bonus comes along they can make a large lump sum payment to take a bite out if the loan principal.

Even salary earners can benefit from an interest-only loan. If they take the savings made by lower repayments and successfully invest them it’s more than possible that they can actually come out with a profit from the deal.

Clearly, then, an interest-only loan can be an excellent option for certain people. However, this type of loan can be a very risky gambit. If the borrower finds it impossible to make those large, irregular repayments to bring down the principal they may find that they end up paying well over the odds over the life of the loan.

In conclusion, those considering interest-only loans should first make sure that they will be able to handle these large, occasional repayments. If they’re not entirely sure they can manage it, it may be best to opt for a safer amortizing loan.