When you send in your monthly home loan payment, part of it goes to pay the lender its interest, and part of it is used to pay off the loan. At least most home loans work like this. A new type of loan has been designed to allow the monthly mortgage payment to be as low as possible, by requiring only the payment of interest.

The home owner can choose how much to pay each month, as long as he pays an amount that will meet the interest, and does not change the loan balance. Of course, most lenders will allow you to pay more than the minimum interest payment any time you want, but that is not the purpose of the loan, which is to keep the monthly payment as low as possible.

Interest only loans were based on the theory that it doesn?t matter that the principal was never reduced, because when the house was sold, the increased value would allow the borrower to pay off the loan. It used to be that homeowners built equity by paying off part of the loan, and by the additional value of the house.

Today?s falling housing market means that borrowers can no longer depend on an automatic increase in their house?s value. There are situations where interest only loans are a good solution. But these situations should only be temporary ones.

Perhaps there is a situation where one partner is not employed or only working part time while he completes school. This is a temporary situation, and as soon as the second partner finishes his studies and starts a job, the loan should be switched to interest plus equity or additional payments should be made to reduce the mortgage.

Another valid situation might be if the primary income owner had an erratic salary pattern, in which he had little to no income for a time and then a windfall income. Such an example may be a project worker who is only paid when the project is complete. While the project is underway, it is best to keep payments as low as possible, a need the interest only mortgage could meet, and then when income is realized, higher payments can be made.

But for any of these cases, the homeowners cannot count on the value of the home rising and has to make sure principal payments are made. If you are paying off the principal a little at a time each month, when it comes time to sell the house, you earned some equity in it, even if home prices have not gone up. If you merely pay the interest each month, you will never lower the principle, and if the home sales price is lower than the mortgage, you will not be able to pay down the loan.

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