Interest-only loans have been around for some time, allowing borrowers to make interest payments each month while avoiding payment on the principal. This is usually used by individuals who want some short-term relief in terms of their monthly payment size. Although this kind of loan is not entirely new, it seems to be surging back onto the market in 2015 with a few different lenders providing access to this kind of product.
Basics of Interest-Only Loans
Since the principal is not factored into the payments, the borrower is only making payments towards the interest on the product. The principal loan amount, therefore, stays the same. This period does not last indefinitely, of course. The borrower will eventually have to pay off the principal, but the loan could be used to help a borrower who needs a payment break in the short term.
Usually, the interest-only period can last from between five and ten years, but this is just the starting point for how these loans work. Home buyers opting for these higher-risk loans are typically aiming to reduce the monthly payments at the outset of their borrowing period. This is most often a kind of loan sought out by those who believe their income potential will grow over the coming years.
Most Common Customers
College students who have recently received a job with promotion and earning potential down the road, for example, might be a good fit for an interest-only loan. The monthly payment is reduced over the short term period, allowing the borrower to wait until his or her income is higher before committing to making payments towards the principal.
Risks of Interest-Only Loans
The fact that payments are lower over the first several years can be problematic for the borrower. If the expected growth in income never occurs, for example, the borrower could find himself or herself buried under a massive home loan. When the interest-only period runs out, a borrower who has not seen the income boost might be struggling to meet the payments. If those payments are continually missed, the borrower is at risk of foreclosure.
Popularity of Interest-Only Loans
These loans were very popular in the late 1990s prior to the housing market crash, but they virtually disappeared when the bubble first. This is because interest-only loans are markedly riskier than other kinds of loans.
In 2015, though, these loans are coming back on the horizon with offerings from several different lenders. Even though these loans appear to be back, this does not mean that they are any freer of risk. The high risk level with these loans is still an issue.
The federal government has even classified these loans as “toxic”. While putting off the higher payments now might seem like a good idea, not being able to catch up down the road presents even further financial issues. The biggest challenge with these loans is that the payments can increase very suddenly, leaving a borrower in the lurch.
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