From what I understand about mortgages, which isn’t a lot at all, I just don’t see any scenario where an interest only mortgage is a good idea.
You pay it off for let’s say 20 years and you still have the full balance remaining. What am I missing?
In: Economics
Interest only loans are typically used by house flippers, they’re advantageous for a couple reasons. First you only have to pay the interest, so if you can buy a $200,000 house and fix and flip it for $350,000 in 1 year, then with an interest only loan at 3%-5% you would only have to pay $6,000-$10,000 for that loan (with the house generally as collateral) and this interest doesn’t compound, so they know they only need to pay $500-$833 per month. This allows a house flipper to significantly minimize their risk. Furthermore, since they don’t own it for a full year, they often don’t have to pay property taxes on the property, (and potentially don’t have to pay much taxes on the loan). Additionally, being able to buy it in cash from a bank (and not using realtors) means they might not need to pay closing costs (which are usually a percentage of the sale).
The downside is that the principle needs to be fully paid off by that small timeframe (~1-5 years).
And is a LOT more expensive per year than a traditional mortgage, since paying down the principle doesn’t reduce the interest amount.
TLDR; house flippers can get a loan for a house very cheaply usually with the house as collateral. This lets them not have to pay a lot of things that would cut into their profit such as; principle payments, property taxes, or sometimes even closing fees, and would allow a house flipper to still make a profit even if they only increased the house value by ~10%-15%.
The big downside is that paying down the principle doesn’t reduce the interest payments, (if you paid it off next year or tomorrow you’d still owe $10,000+ principle).
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