Interest Only Loans
In the United States, a five or ten year interest-only period is typical. After this time, the principal balance is amortized for the remaining term. In other words, if a borrower had a thirty-year mortgage and the first ten years were interest only, at the end of the first ten years, the principal balance would be amortized for the remaining period of twenty years.
The practical result is that the early repayments (in the interest-only period) are substantially lower than the later repayments. This enables a borrower who expects to increase their salary substantially over the course of the loan to borrow more than they would have otherwise been able to afford, or investors to generate cashflow when they might not otherwise be able to. During the interest-only years of the mortgage, one is essentially renting the house since none of the principal loan decreases. The two great disadvantages are that in many states one has to pay property tax and purchase mandatory property insurance.
On the other hand, the owner is still gathering appreciation, even if they aren’t paying down equity against their loan, and there are many other tax advantages to home ownership not available to renters. In cases of aggressive appreciation (e.g. “flipping” homes), a 100% mortgage-to-value interest-only loan may also be able to be converted to a conventional mortgage with a more favorable mortgage-to-value loan, resulting in an overall lower payment.
