An interest only loan is only good in the following circumstances:
1) housing in your area is appreciating like wildfire. If it's not then
2) you pay off your mortgage at the very least as if it were a regular amortizing loan... the best case scenario is if you make the same payments as if you had a regular fixed rate mortgage.
The benefit of an interest only loan is that it essentially allows you to manage your own finances. If you are going to use it to be able to "afford" more house than you normally would be able to afford, then quite honestly, it's a HUGE gamble, especially right now. Housing is not appreciating nearly as quickly as it was a few years ago and you run the risk of negative amortization (actually owing more than your house is worth if you need to sell for whatever reason or at the point where you have to start paying principle on your loan). Here is an
explanation of negative amortization. Basically that "cap" that Aprille mentions can really bite you in the butt if you are only paying the "interest only" amount and interest rates are on the rise.
If you are going to use it to use the low interest rates to your advantage in order to leverage yourself into a better financial position, then it's a very savvy move. Basically, like all tools it can be very useful if you understand how to use it but if you don't, you can seriously hurt yourself.
Although the 30 FRM is the most popular program out there, it is also the most expensive in terms of interest rates and how much you will eventually pay for your house. Something like 95% of people don't last more than 7 years in the same loan program (some move and sell the house, the rest will refinance at some point because of life changing circumstances), therefore they end up paying a HUGE premium for the traditional FRM because of the way interest is front loaded and you pay so little principle in the first few years.
If I could predict where rates are going to be in a few years, I'd be rich... but most people seem to think they are not going to go sky high. The reasons I have read about are varied... one is that everyone knows what super high interest rates does to the economy (remember the 70's?) Another is that although prime has nowhere to go but up, most mortgage rates are not directly tied to the prime lending rate. In fact, when the fed raised prime by .25% a few weeks ago, everyone who had been rushing to rate lock before that happened got screwed, as 30 year FRM rates actually went DOWN by nearly a quarter of a point on average. In many ways, the rates that you see now probably won't vary greatly for a while because they are already up nearly a point (sometimes more) from their "historic lows" to absorb the effects of some of the effects on the economy of raising the prime lending rate. I've heard someone else say that things are cyclical and interest rates haven't stayed low nearly long enough to make up for the damage the really high interest rates had.
All that said, you really need to make an educated choice. Going simply by what the payment will be is just about the most uneducated way to make a choice... you need to understand what the various programs are, what they do to your loan balance, what the worst case scenarios are and how to leverage yourself against those worst case scenarios.
We also got a higher LINE, so that we could make improvements/updates to the house without again taking a 2nd loan, home equity loan, to do all that.
