When you send in your monthly mortgage 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. Banks have now come up with a new type of mortgage titled interest only.

The home owner can choose how much to pay each month, as long as he pays an amount that will satisfy the interest, and does not change the principal. In most home loans, you have the option to pay more than the fixed mortgage payment, but the difference is that the interest only mortgage keeps the monthly payment as low as possible.

There may have been some rationale to this kind of loan when property prices were increasing drastically, since the borrower would be guaranteed some equity because of the increased home price. Normally, equity in a property is gained by a combination of paying off the principal and rising home values.

However, changes in the real estate market mean that this type of increased value is no longer guaranteed, so any equity has to be built by paying off the principle. Interest only loans may have a value in certain situations where you have to keep the monthly payment low. Today, it would really only work if it were used as a stop gap measure.

Suppose, for example, that a couple bought a home at the time when one of them was employed and one of them was still in school. This is a temporary situation, and when 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.

Or suppose a home owner has a erratic type of income, in that he earns very little for a while and subsequently receives a large payment. An example of this may be someone who performed project work and was only paid at the completion of each project. 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 price of the home rising and has to make sure principal payments are made. As mentioned, with ?old fashioned? mortgages, the loan was paid down eventually because part of the monthly payment went towards principal, so the owner had some equity even when the value of the house did not go up. If the owner only pays interest, the mortgage balance never goes down, so if the owner sells in today?s market of falling prices, he may not receive enough to pay down the mortgage.

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