In the old fashioned mortgage mortgage market, you pay a part of your loan, and the monthly interest with each monthly mortgage payment you make. This was how all mortgages were until now. Some lenders have now introduced a new kind of loan to attract more customers by keeping the monthly mortgage as low as possible by only paying the interest.

The homeowner can pay whatever amount he wants, as long as he pays the minimum amount of the interest due each month. In most mortgages, you have a choice to pay more than the fixed loan payment, but the difference is that the interest only loan will keep the monthly payment as low as possible.

Interest only loans were based on the theory that it doesn’t matter that the loan was never reduced, because when the home was sold, the increased value would allow the borrower to pay off the loan. Normally, equity in a home is gained by a combination of paying off the loan value and rising home values.

But the housing market now cannot guarantee that you will gain equity in your home just through market increases. Interest only loans may have a value in certain situations where you have to keep the monthly payment low. Today, it would really only work if it were used as a stop gap measure.

Let us say there is a situation where one partner is not employed or only working part time while he completes school. The assumption is that he will be able to pay more for mortgage once school is finished and therefore they will be able to make higher payments.

Another valid situation would be if the primary income owner had an erratic earning pattern, in which he had little to no earnings for a period and then a windfall income. An example of this could be someone who did project work and was only paid at the completion of each project. When income is low, the lower payment (interest only) option could be used and then when the windfall income was received, higher payments could be made to pay down the loan.

In the current housing environment, not building equity by paying down the loan could be a dangerous situation. Using a traditional loan mechanism, if the home value is lower, flat or only increases slightly, the margin of equity that the borrower deposited will cover the difference. If no equity has been paid off, the owner will have to find additional money to pay off the mortgage if home values have not sufficiently improved.

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