Understanding the Risks of an Interest Only Loan

Are you planning to settle for an interest only loan? An interest only loan is a popular option among borrowers or property investors, though it seems like a great idea but there are some risks associated with it. Before you make your mind to go for an interest only loan, here is some information worth considering.What is an Interest Only Loan or Interest only mortgage?An interest only loan is what exactly it sounds like: In this, a borrower needs to repay the interest on the loan only rather than paying both interest & principal together thus allowing borrower to reduce the monthly cash flow commitments. Many mortgage lenders offer this option, wherein only interest is charged on home loans. However, there is a catch in this. Let's have a look at the implied risks associated with it. Risks Associated with the Interest Only LoanOne of the biggest risks of an interest only mortgage is that a borrower keeps paying for years with nil progress in paying off the loan principal. Thus, even once you are done with the interest amount you still owe as much principal as you had at the initial phase. This means you have not even started with payment of actual principal amount.Secondly, when you opt for an interest only route as a borrower you won't be gaining any equity in the property despite of making monthly repayments. So, in case you plan to invest in new property and think of using equity in your first property as a reference for the next you will realize you have none. With interest only mortgage option one of the catch is you are not able to build your property portfolio.

Lastly, every borrower or say property investor when opts for interest only loans goes with the belief that within few years like 5to 7 years, the property value will be increased thus resulting in effectively gaining equity without having to pay a single cent towards the principal. Now here comes the risk associated with it- consider the scenario if property doesn't increase in value or not increases enough? Then borrower is left with the property that is worthless in terms of equity. The only rescue in this case is, adding additional value to the property by some renovation.No matter which loan option you are considering, seeking the advice of financial experts is a great way to ensure that you are able to pick the best option that coincides with your financial situation.

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