Pros and Cons of Interest-Only Loans

Interest-only loans are a type of loan that requires you to only pay the interest that has accrued during the month for your loan payment. With this loan, you will make only interest payments during the life of the loan. After the interest only period is over, the borrower will then make a large balloon payment at the end of the term to retire the principal balance. In comparison, with traditional loans, a portion of your payment goes towards the interest as well as the principal balance each month. Here are some of the pros and cons associated with interest-only loans.

Pros

The biggest advantage of utilizing an interest-only loan is that your monthly loan payment will be significantly smaller than a traditional, fully amortized, loan. If you have a traditional loan, you can pay hundreds of dollars more every month. Many people cannot afford large payments and interest-only loans give them another option to consider.

With an interest-only loan, you can free up more of your expendable cash. Many people do not like to invest a lot of money into certain assets. They believe that they would be better off by saving their money and investing it into the market. In many cases, they are right because the market will provide superior returns as long as you choose the right investments. This allows individuals to make a bigger return and then when the loan is due, they will have enough money to pay it off.

Cons

Even though an interest-only loan can save you some money on a monthly basis, you will generally be paying more money over the long-term. With interest-only loans, the interest rates are typically higher than what you could get with a traditional fixed-rate loan. In many cases, interest-only loans have an adjustable interest rate associated with them.

Another disadvantage of interest-only loans is that they require you to make a balloon payment at the end of the loan term. The balloon payment will be for the entire amount of money that you originally borrowed. This means that you will spend a long period of time making interest payments to the lender, and then you will owe the entire loan amount that you originally borrowed. Many times, people do not take the proper precautions to plan for the balloon payment and it catches them off guard. When this happens, they do not have enough money to pay the balloon payment and have to go to an alternative plan. Many times, this results in refinancing the loan and starting all over or selling the asset. 

In many cases, interest-only loans are also considered to be short-term loans. Most of the time, this is only a short-term solution for an individual to work with. When you utilize this type of solution, you will have to work on coming up with some other financing arrangement in the future. Because of this, you might end up paying more money and closing costs and fees to the lender on top of the extra interest that you paid.

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