Here’s my take on interest-only loans.
For some borrowers, the interest-only loan is great. If you want to qualify for as high a loan amount as possible with the lowest monthly payment, this is a possibility. If you are planning on owning the property for a short period of time and selling it at a higher price, an interest-only loan will maximize your profit. If you can put the extra monthly cash flow into investments that perform better than your loan’s interest rate, then go for it.
The downside of interest-only loans worries me. What if we’re in a real estate bubble and the property value declines? (Just like very recently) You could have negative equity in the property – the loan amount due might be higher than your property value. If you plan to hold the building a long time or if you live in it, the future interest rate adjustment can hurt you, especially considering the historically low fixed-rate loans now available.
When you have a traditional amortizing loan, you know you are making progress every month paying off the loan. You are building equity. When you are paying interest only, you are never making progress paying off the loan balance. You are giving up one of the four financial benefits of real estate. The rates I noticed for interest-only loans seem in general slightly higher than comparable loans where the loan pays both principal and interest.
The advantages of the negatively amortizing loan the broker presented to me are the same as the interest-only loan: higher loan amounts approved, lower monthly payments, and improved monthly cash flow.
The downside is even worse than with the interest-only loan. The loan balance grows every month, and this can lead to negative equity even more quickly. As the man in the commercial says, “You can pay me now, or you can pay me later.” My preference is to pay now rather than have regrets later.
Final Words On Financing
Overall, the financing you have on a property is a key ingredient in the success or failure of the investment. It’s to your advantage to have a complete package available to the lender so that it’s easy for the lender to say yes to your loan request. Shop the market wisely to get the best deal you can from your lender. A quarter of a percentage point on a million-dollar loan adds up to a lot of interest over a five- or ten-year period.
With the financing in place and the various other contingencies met, you are now ready to finalize, or close, on a purchase agreement.