Interest only loans come in several varieties.

Interest-only loans come in all flavors. With some, you lock in a fixed interest rate for the life of the
loan, while others resemble adjustable rate mortgages which carry a fixed rate for a certain number
of years, and then adjust every six months to a year.

The most popular interest-only product resembles a 5-year adjustable-rate mortgage, but requires
that you pay only interest, no principal, for the first five years.

The initial savings can be quite impressive.

Let's say you borrow $210,000 using an interest only loan with a 5.75 percent rate and no principal
payments due for five years. Your monthly payment will be just $1,006, or about $220 a month less
than if you went with a regular 5-year adjustable rate mortgage with the same rate.

Compare this interest-only loan with a 30-year fixed loan of 6.25 percent, and your savings are $440 a
month. That adds up to $26,000 in lower monthly payments for the first five years of the loan.

If you're the gambling sort, you could get into an interest-only product and bet that the market will build
equity for you. In California or Nevada, it would be a good bet that it would. Paying down principal is not
as much of a concern for people with shorter time horizons, particularly if home prices are going up.

Of course, there's never a guarantee that prices will appreciate. And if you stay in the house longer than
you planned, your monthly payment jumps drastically after your five-year honeymoon period. Suddenly
you have to pay principal on the loan, and most likely at a higher rate. If your rate goes to 7 percent for
the life of the loan (and there's nothing stopping it from going higher), your payments will nearly double
to $1,413.

If you go the interest-only route, you're wise to set up an automatic deduction to an investment or
savings account. Doing so will dampen the risk that you spend your savings and make it easier to
swallow higher payments down the road.

Interest-only loans also make sense for people whose income is sporadic, either because they are
paid on commission or because they receive annual bonuses. In this case, they have the option of only
paying interest some months but can pay above and beyond the amount due when they get their bonus
checks. There are lenders who offer no prepayment penalty options on interest only loans.

Of course, this kind of strategy also requires that you're disciplined enough to sign your bonus check
off to your lender rather than taking it to the Caribbean.