When you pay your monthly mortgage payment, you may have noticed that a part of it (however small) reduces the loan and the rest of it pays the interest. That?s the way a typical mortgage works. Some lenders have now introduced a new kind of loan to attract more borrowers by keeping the monthly payment as low as possible by only paying the interest.

This means that if you pick an interest only option, every month you pay your loan, the loan balance stays just the same; it never gets lower. In most home loans, you have a choice to pay more than the fixed loan payment, but the difference is that the interest only mortgage keeps the monthly payment as low as possible.

This loan had a place when housing prices were skyrocketing, since even if you never paid down some of your mortgage, you would still have plenty of equity because of the house?s increased price. The combination of increased equity due to market increases, and the paydown of the principle guaranteed most homeowners some residual value in the house when sold.

But the real estate market now does not mean that you will earn equity in your home just through market increases. There may be some instances where interest only loans can be beneficial. But these cases should only be temporary ones.

One example may be when a two income couple temporarily only has one income, for instance if one of them was going to school. Since, in theory, the student would eventually complete school and get a good job, keeping the mortgage payment low during this period and ramping them up later makes sense.

Another example would be where the homeowner has income that fluctuates greatly from month to month. Perhaps someone who worked on large projects and was only paid at the end of them might have such a situation. When income is low, the lower payment (interest only) option could be used and then when the windfall income was received, higher payments could be made to pay down the loan.

But for any of these cases, the homeowners cannot count on the price of the home rising and has to make sure principal payments are made. Using a traditional loan mechanism, if the home value is lower, flat or only increases slightly, the margin of equity that the borrower deposited will cover the difference. If you only pay the interest each month, you will never reduce the principle, and if the home sales price is lower than the home loan, you will not be able to pay off the loan.

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