In the traditional mortgage mortgage market, you pay a part of your loan, and the monthly interest with each monthly mortgage payment you make. At least most home loans work like this. Lenders have now come up with a new type of loan called interest only.

The borrower can pay whatever amount he prefers, as long as he pays the minimum amount of the interest due each time. Of course, most lenders will allow you to pay more than the minimum interest payment each time you want, but that defeats the purpose of the loan, which is to keep the mortgage payment as low as possible.

This loan had its place when housing prices were escalating, since even if you never paid down part of your mortgage, you would still have plenty of equity because of the home?s increased value. Normally, equity in a home is gained by a combination of paying off the principal and increasing home values.

Now that real estate values are falling instead of rising, the logic of interest only loans has been called into question. The only reason that one would prefer to have an interest only loan is to keep the monthly payment as low as possible. But these situations should only be temporary situations.

A good example would be if one partner to the mortgage was attending school and the other was employed. The assumption is that he will be in a position to pay more for mortgage once school is finished and therefore they can make higher payments.

Another valid situation would be if the primary income owner had an erratic earning pattern, in which he had little to no income for a time and then a windfall income. Perhaps someone who worked on large projects and was only paid at the completion of them might have such a pattern. Keeping payments low in the months when income was low and then paying additional equity when the windfall came would be a sensible decision, as long as the discipline was there to make the extra payments.

In the current real estate environment, not building equity by reducing the loan is a dangerous situation. As mentioned, with ?old fashioned? home loans, the mortgage was paid down eventually because part of the monthly payment went towards principal, so the owner had some equity even if the value of the home did not go up. If the owner only pays interest, the loan balance never goes down, so if the owner sells in today?s market of declining prices, he may not recuperate enough to pay off the mortgage.

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