IO’s: Low Interest Loan with High-Risk Costs
Initially, an interest only loan, or perhaps IO, would seem to be the ideal low interest loan for a duration of five or ten years, you pay nothing but interest costs (which, on a low interest loan, can be almost nothing in comparison to traditional mortgages), thereby lowering your payments and making it possible to purchase a higher priced house than you’ll have been able to pay for, otherwise. But why don’t we stop just a minute and see whether this low interest loan is really all it’s cracked up to be.
The thing about a mortgage payment is that you have two figures you are dealing with first, the expense of the house second, the expense of the interest. Traditional home loans start off as mainly interest with a tiny part of your monthly premiums going towards lowering principle–that is, the cost of the particular house–but as the principle is gradually lowered, your amount of interest you’re spending each month begins to reduce, so that more of the payment goes toward principle. The result is a kind of snowball effect that, especially with fixed rate home loans, pays off your home inside slow but constant segments no unpleasant shocks, no impolite surprises.
With an interest only loan, however, you’re paying only interest for your first five to ten a long time. That tiny bit associated with payment on basic principle (which gradually boosts to a large payment on principle weight loss of the principle pays off and charges become smaller) will be missing–which leads to a short term acquire, but, perhaps, a permanent loss. Because, the thing is, at the end of those five-years, *you still have the entire repayment to make*, only now you’ve got only 25 years in order to spread payments above, rather than 30 or 35 years. This is bad news for most property owners, even if you have a a low interest rate loan. This means a huge begin payments, and it need to cause most people to believe long and hard about whether this kind of loan, low interest loan or not, is right for them.