This post is part of my Freaky Financial Fridays series, where I argue a case from an opposing view, generally in contradiction to my own philosophy or conventional financial advice.

Interest only mortgages are often associated with the sub-prime meltdown and generally dismissed by responsible financial advisers.  While interest only loans are often poor vehicles for potential homeowners, there is one type of buyer who could stand to gain from their use.

Interest only mortgages are just that, only the interest portion of the loan is paid each month.  At the end of the term you’d owe just as much as when you started because no principal payments had been applied.  Unless the house appreciated, which is of course possible but less likely in today’s market, you would have zero equity in the home.  The one upside to that huge downside is that your monthly payment will be lower.  This fact has caused many homeowners to buy more home than they could afford, since interest plus principal payments would be beyond their means.

The problem with interest only loans comes when people spend the extra money that they are saving by having a lower payment.  If your mortgage would be $1200 towards interest and $200 towards principal, an interest only loan can be beneficial if you do something constructive with the $200.  If you spend it, you likely will be worse off.

Those looking to save and invest that extra money could be better off if they can find a higher return than their mortgage offers.  This is the same argument for anyone trying to decide if prepaying their mortgage is a mistake.  Let’s assume your mortgage interest rate is 7% and you’re in the 28% tax bracket.  Since you get to deduct mortgage interest on your tax return, your effective rate is 7%x(1-28%) or about 5%.  Finding an investment that beats 5% isn’t terribly difficult, even in these market conditions.  Note that the actual rate you’d have to find is 7% pretax for short term investments or 5.93% for long term.

Minimizing payments to free up more of your money for investments is also the case made by many people who buck conventional wisdom and choose to rent versus buy, despite the ability to easily afford a home.  SmartMoney had a great article about how renting can make you rich.  I was led there by squawkfox’s Why Good Debt is a Lie.   Other informative posts on topic come from Millionaire Mommy Next Door including Rent versus Buy: The Hidden Cost of Lost Opportunity and Rent, Grow Rich, Be Free.  The authors of those posts will probably cringe to see their insight being referenced in a post advocating a use for interest only mortgages (even a Freaky Financial Friday post), but their logic applies here as well.

Above your interest payment towards your mortgage, any additional money can be invested in many ways.  While a forced payment towards principal, at a known rate of return is a standard option, it isn’t the only one.  Investors with the skills to find better returns and the commitment to invest any money saved through lower monthly payments can stand to do better by not prepaying their mortgage in the more conservative method, or opting for an interest only mortgage in the more aggressive method.