IO’s: A low interest rate Loan with High-Risk Costs
At first glance, an interest only loan, or perhaps IO, would seem to be the perfect low interest loan for a amount of five or ten years, you have to pay nothing but interest expenses (which, on a low interest rate loan, can be almost nothing when compared with traditional mortgages), thereby lowering your payments as well as making it possible to purchase a more costly house than you would have been able to pay for, otherwise. But why don’t we stop just a minute and see whether this particular low interest loan is really all it’s cracked as much as be.
The thing about a mortgage payment is that you have two figures you are dealing with first, the price of the house second, the cost of the interest. Traditional home loans start off as mainly interest with a little part of your monthly obligations going towards reducing principle–that is, the cost of the actual house–but as the principle is gradually lowered, the actual amount of interest you’re spending each month begins to reduce, so that more of your payment goes toward principle. The result is a type of snowball effect which, especially with fixed rate mortgage loans, pays off your home in slow but constant segments no nasty shocks, no rude or obnoxious surprises.
With an interest simply loan, however, you’re spending only interest for the first five to ten years. That tiny bit regarding payment on basic principle (which gradually raises to a large transaction on principle weight loss of the principle is paid off and charges become smaller) is missing–which leads to a short term acquire, but, perhaps, a lasting loss. Because, the truth is, at the end of those five-years, *you still have the entire transaction to make*, only now you’ve got only 25 years to spread payments over, rather than 30 or even 35 years. This is bad news for most homeowners, even if you have a a low interest rate loan. This means a huge start payments, and it ought to cause most people to think long and hard about whether this kind of loan, low interest loan or otherwise not, is right for them.