> Let's suppose I get an interest only loan to buy a house.
>
> That would minimize my house payment.
Sort of. In a "normal" loan, part of your payment is "to you" -- in the form of equity. Whether you "count" that as being "payment" or not is up to you. The common complaint is that you can't get access to that equity without selling the house, but HELCs have (approximately) "solved" that problem ...
> I could deduct all my house payments because they'd be all interest.
Right, but you'd be gaining no equity. Also don't forget that a dollar of expense, even if it's deductible, is worth less than not having the expense in the first place. This is doubly-true if you aren't able to take advantage of the deduction (say if you're an 1040A filer).
> If I can manage not to sell the house at a loss, I'd only be
> out the interest (and maintenance).
>
> What am I missing?
- If you don't manage to sell the house at a loss :) you'd have to come up with that missing equity in order to sell it.
- You'd be paying more interest over the term of the loan (as your equity increases, your interst payments go down)
- If you stayed in the house for longer than the US average (5-7 years?) it would be more expensive.
- If you don't have a 20% down payment, you'll never get rid of PMI
An interest-only loan on a house starts to look kind of like a lease, and leasing only makes sense in certain conditions. Here are a few:
- You're not going to stay in the house for longer than 5-7 years (in which case having ready-access to the equity won't cost you that much and could be very useful in other ways)
- You're living on a "fixed income" ... perhaps you're old, and the equity in your house is going to get passed to your kids. There's no reason for you to continue adding to your equity.
- You have more than 20% down and aren't paying PMI
-----
Here's an example with a $500k house and 20% down (so a $400k mortgage) at 5% (high for today, but still):
Monthly payment: $2147.29; in that first month, $480 of it is equity, and it goes up to $614 by the end of 5 years. After 5 years, you've paid $96,152.12 in interest or approximately $1602.54/month. And you've added $32,685.05 to your equity, $544.75/month (less in the first months, more in the later ones).
An interest-only 5% loan would cost you $1666.67/mo for a total of $100,000 over 5 years. I haven't looked recently, but while there was a time in the last decade when interest-only loans were priced the same as normal ones, I think they are slightly more expensive -- half a percent? -- these days.
So: if $1666.67/mo looks "less" than $2,147.29 (even though at the end $100,000 is clearly "more" than $96,152.12) then what you're saying is that it's worth it to you to pay about $64/mo to not "have to" accumulate $544/mo of equity.
In the extreme case, if you stay 30 years, you would have paid a total of $373,023 interest for a normal loan (and you'd own the house outright) vs. $600,000 for an interest-only loan (and you'd still only have $100,000 of equity). Clearly a bad deal.
Interest-only can be a powerful tool, but it's not a slam dunk in all cases.
/jordan