What’s the point of an interest only loan? Do they have a place in today’s environment? An interest only loan is a mortgage that operates as its name applies, the only thing that’s due every month is the interest on the note. Is this a good thing? Something to consider as a real estate investor or should interest only loansthey be avoided?

Interest only loans today fall outside the parameters of certain mortgage lenders today. The Consumer Financial Protection Bureau, or CFPB, implemented new guidelines that residential mortgage loans must meet. Doing so means the lender is provided a “safe harbor” should litigation arise later due to some facet of the loan. As long as the lender that originated and underwrote the loan using these standards, the protection is granted. However, an interest only loan disqualifies a mortgage for a primary residence for safe harbor protection. These standards apply to an owner occupied property and not to investment real estate. That hasn’t stopped certain lenders from applying these additional guidelines to investment real estate however.

Yet an interest only loan can make sense. It certainly helps the monthly cash flow as the monthly payments are lower. However, only paying interest over the course of the loan doesn’t pay down the loan balance and equity is only gained through property appreciation. An interest only loan can be a quality choice due to its flexibility. The borrower chooses when to pay down the loan, not the other way around. Say an investor sells a property and uses the proceeds to pay down an existing note. Instead of making a small principal pay down each month, a considerable chunk can be paid off with one fell swoop of a closing. There aren’t as many lenders who offer interest only loans compared to fully amortized ones, but they are something to consider with the right borrower. Don’t ignore them completely.