There has been a lot of publicity and media attention regarding Interest only loans.  First let me inform you that Interest only loans have been around for about 10 years, so they are nothing really new, however they have become more popular the last 3 years due to the substantial rising housing prices in many markets across the country.

How does it work?

Essentially an interest only loan is what it implies, your minimum payment is interest only.  As with an amortizable loan that you are obligated to pay principal and interest on a monthly basis, the interest only loan allows you the option to pay more than interest should you decide to, but the minimum payment is still interest only.

A payment example would be...

Let's take a $500,000 loan at 5% interest only.  The monthly payment would be:

(500,000 x 0.05)/12 = $2,083 (interest only)

How does that compare with a regular amortizable loan?

Let's take the same $500,000 and amortize it.  The monthly payment would be:

(500,000 x 5.37) = $2,685 (principal & interest)

(the 5.37 is from an amortizable table)

The interest only payment is $602 less per month, which allows us to qualify the borrower for 20 to 25% more loan amount.

What is the recast feature on an interest only loan?

Let's take that $500,000 loan, and say that you fell upon $50,000 and you want to pay your loan down to $450,000.  How is your payment affected?

Your new payment will be:

(450,000 x 0.05)/12 = $1,875

This is $208 lower than the $2,083 you were paying when the loan amount was $500,000.  This feature is called a 'recast.'

As with all loans, the lenders will want you to eventually pay down principal.  So, the interest only loan can help you qualify for that big loan and keep your payment down, but how you manage the principal is of importance.