When you send in your monthly mortgage payment, part of it goes to pay the lender its interest, and part of it goes to pay off the loan. At least most home loans work this way. Some banks have now introduced a new type of loan to attract more borrowers by keeping the monthly payment as low as possible by only paying the interest.

The borrower can pay whatever amount he wants, as long as he pays the minimum payment of the interest due each time. 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 mortgage payment as low as possible.

There may have been some reason for this kind of loan when home prices were increasing dramatically, since the borrower would be guaranteed some equity because of the increased home price. It used to be that homeowners built equity by paying down part of the loan, and by the additional value of the house.

Now that home values are falling rather than rising, the validity of interest only loans has been called into question. There are cases where interest only loans are a good solution. This might be valid option if it were a temporary situation.

Suppose, for example, that a couple bought a home at the time when one of them was working and one of them was still studying. Since, in theory, the student would eventually complete his studies and get a good job, keeping the mortgage payment low during this period and ramping them up afterwards makes sense.

Or perhaps a home owner has a sporadic type of income, in that he earns very little for a while and subsequently receives a large payment. Maybe a project worker is only paid at the end of a project. Keeping the mortgage low in the months when income was low and then paying additional equity when the windfall came would make sense, as long as the discipline was there to make the extra payments.

In any of these instances, it is dangerous to not boost the payment at some point in so as to bring the mortgage balance down. Using a traditional loan mechanism, if the home value is lower, flat or only goes up slightly, the margin of equity that the borrower deposited will cover the difference. If no equity has been paid down, the owner will have to find additional cash to pay off the mortgage when home values have not sufficiently increased.

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