An interest only loan may be a good short term deal.

Interest only loans are not meant to be a long-term proposition, but they can be good in the short run.

Interest only loans usually make the most sense when a large amount of money is being borrowed. At smaller loan amounts, the savings may not offset this loan's downside. And, interest-only loans aren't really designed to be long term. So, most borrowers who get them plan to either sell their homes, or refinance them before the interest-only period ends.

It's reported the average time in a home is three to five years before the owner sells or refinances. For the borrower who plans on staying in the home for 10 years or more, they might not like their higher payments when the interest only option expires.

Interest-only mortgages were actually introduced in the 1920s, when borrowers wanted to free up money for stock investments. The great Depression ended that kind of thinking, but in the time since then, some banks have made interest only mortgages available to their preferred clients. Many of these borrowers had substantial real estate assets, and were money savvy and quite knowledgable about managing their portfolios. Building equity in their homes was not of great concern.

In the past few years, soaring real estate prices and house hungry borrowers helped spark a renewed interest for these types of mortgages. And, there's now more of an appetite for these loans than ever before.

Interest-only borrowers seem to be of two types:

Those with rising incomes. These people, many of whom are first-time home buyers, are grabbing interest interest only mortgages because they enable them to buy a bigger home than they might ordinarily qualify for using more traditional financing like a 30-year fixed mortgage.

Money Managers. Other borrowers just want smaller payments. They may be
paying off other, higher interest debt, which also may not be tax deductible. Or, they may feel they can earn better with other investments rather than their own home.

There are also those borrowers who are counting on rising markets to build equity for them; especially in states like California, Nevada and Arizona where appreciation is high and fast.

This is a strategy that may work well while home prices rise, but not so well if there's a "hiccup" in real estate values. If a borrower needs to sell when prices are falling, there could be a substantial loss in the making.