Interest only home loans have been under the spotlight recently, with some arguing that they have been the subject of a similar amount of miss-selling as was previously the case with endowment mortgages. Too many others, however, interest only mortgages are the only really viable way they'll be able to purchase a new home. So, what are interest only home loans and how do they work?
Similar to a repayment home loan, an interest only home loan is a loan secured against the property purchased – more commonly known as a mortgage. Where interest only and repayment home loans differ, however, is in the manner in which the home loan is repaid. With a repayment home loan, the borrower and lender calculate the period of time to repay the loan, and then divide the principal by the number of months to acquire a principal amount that needs to be repaid each month in order for the home loan to be repaid in full. Interest is then charged on the loan and this interest is then repaid each month too. With an interest only repayment home loan, as the name suggests, no principal amount needs to be repaid each month, only the interest that has accrued on that principal amount. The principal on the interest only home loan will then be repaid in what is known as a bullet-shot one off payment on the day the loan matures, in much the same way as the principal is paid off on an endowment mortgage.
However, the concern being raised between the difference between an interest only repayment mortgage and an endowment home loan is that unlike with an endowment home loan, the borrower of an interest only home loan mortgage is not always being required to show evidence of investing in some form of underlying investment each month that will eventually help to cover the repayment of the principal sum or any short-fall thereof when either the underlying investment matures or when the home loan matures.
To compensate for the short-fall above, it is possible to have open-ended interest only home loans that will continue to only charge interest on the loan until such time as the borrower has some means of repaying the principal, such as if the homeowner decides to sell the home. Nonetheless, similarities can be drawn here between a straight rental arrangement, with the bank acting as the landlord, and home ownership as it is traditionally know as the borrower effectively pays an amount each month to keep the principal sum of the loan static.
It should be noted, however, that if the equity value of the property were to fall below that of the outstanding principal sum on the home loan mortgage, then it is likely that the bank would request that you make a payment towards to the principal outstanding so as to ensure that the principal sum never goes below the value of the property.
Regardless of all this, with the spiraling cost of property ownership these days, interest only home loan mortgages are a favored method of borrowing, as they are perceived as being more affordable over the long run. Needless to say, however, if you do have an interest only home loan you need to make sure you keep a very careful eye on where interest rates are going as this is going to have a direct effect on your monthly repayments.