Understanding the benefit of non principal repayment loan

I want to understand the benefit of a certain type of loan. Let's say a bank is offering me the possibility to grant me a mortgage loan for 100k for 1.5% interest with a repayment period of 30 years. The difference is that I don't have to repay the principal at all for those 30 years, only the interest. The principal I have to repay as a one-off in 30 years. What I would like to understand is how beneficial is this arrangement.

https://www.calculator.net/loan-calculator.html?cloanamount=100%2C000&cloanterm=30&cloantermmonth=0&cinterestrate=1.5&ccompound=daily&cpayback=month&x=Calculate&type=1#monthlyfixedr

Using this website, I assumed that this arrangement saves me annually the equivalent of the principal repayments, which I could subsequently invest in something else during those 30 years.

My question is, am I understanding this correctly? Are there potential benefits / drawbacks that I am missing?

Interest-only repayments mortgages are fairly popular in Switzerland, though there is a mandate that the borrower should pay something like 20% of the home value "cash" to qualify for the loan -- which gives the bank a safety margin, since as long as the home value doesn't go down by more than 20%, they can sell the home and recover their investment.

Advantages for the borrower:

Disadvantages for the borrower:

In my opinion, interest-only repayments mortgages are most interesting if you do NOT intend to keep the home, or pass it on, and couldn't otherwise afford such a nice home. The end-plan, then, is to sell the home to repay the mortgage. And if the home would sell for less, that is the bank issue (see 2008 crisis).

Apart from that, I would be wary of the greater overall cost. Yes, in theory, you could invest the money you do not repay, get interest on it, etc... but between the fact that the interest you can get on the money you invest is relatively unlikely to be that much more than the interest you pay on the mortgage AND the fact that any interest gained on investments will be taxed, I would be quite worried about not being able to close the gap.

Also, there's a notable risk of a change in the "investment" landscape. 30 years is a considerable period of time, over which the available investments, the tax laws, etc... may all change quite drastically. Thus, any calculation run with today's available investments & tax laws in mind should offer a comfortable safety margin... at least. As an example, imagine that capital gains are taxed 2x or 3x more as a new measure to make up for the deficit/ballooning national debt... this could completely foil the investment plan!

And finally, I would like to point out the ups & downs of financial markets. With a 30 years horizon, it's reasonable to aim for S&P 500 at the beginning, however it's unreasonable to keep the money invested in S&P 500 until the very end: a temporary market crash could wipe out all the gains just before you absolutely need the money for the lump sum payment! This means that as the term approaches, your investment should gradually shift towards safer instruments -- bonds, for example -- however doing so will generally reduce the average gains you can hope for... meaning that your investment plan SHOULDN'T count on getting the average S&P 500 gains for 30 years. Yet another reason making up the lump sum is NOT going to be simple.

This was a somewhat popular option in the United Sates back in the 2004-2008 time frame.

Since the amount of the monthly payment was lower with this type of loan, the required monthly income was easier to qualify for.

Another reason it was popular was that the principal portion of the monthly payments isn't tax deductible, but the mortgage interest payments, along with their state income tax, and property tax are deductible. This type of loan didn't have principal portion, this meant they weren't spending money on a non-deductible expense. This time period was before the SALT limits from the 2017 tax changes.

This worked perfectly if the value of the house increased while the mortgage was interest only. But if that didn't happen, or even worse if the value of the home crashed then it was more likely that the seller had to bring a check to closing when they sold the house.

The problem is that if the only way you can even reasonably afford the house is through a gimmick mortgage, then the whole purchase is on thin ice. Other tricks were payments that were smaller than required and the mortgage balance increased each month.

When prices dropped in the 2006-2010 period many loans were underwater, or people couldn't afford to sell.

The benefit to you is that you can get a slightly bigger loan because you don't have to make the principal part of the payment. I say slightly bigger because with a traditional 30-year mortgage the principal portion is initially only about 10%-15% of your monthly payment depending on the interest rate (with current rates being around 7%). So you could borrow about 10% more, all else being equal.

The benefit to the bank is that they get the same interest amount over 30 years instead of the interest dwindling over time.

The drawback to you is that in 30 years you'll have a massive balloon payment due that you'll either have to refinance or risk losing the house in foreclosure.

Another drawback is that interest-only loans tend to have higher interest rates because they are used for higher-risk borrowers. Lenders can charge a higher interest rate for the same monthly payment because there is no principal portion.

With an interest-only loan you are essentially "renting" the house - you are not building any equity other then the increase in market value when you go to sell it.

Roughly speaking you are borrowing the amount you would have paid in principal at the note rate, tax deductible to the extent the interest is. If the interest rate is low enough you want that loan, take it. In your example the payment would be 125/mo instead of 345/mo. If you can invest the 220/mo at better than 1.5% you will have more than 100k at the end of 30 years, can make the balloon payment, and be cash ahead. Bonds are paying more than that now and look to do so for the foreseeable future. Liquidity can also be valuable. If you take the amortized loan and wind up borrowing money for any reason, taking it out of these savings may be less expensive than other options. On the other hand I would be amazed if you can get an interest only mortgage (or any other kind) at 1.5%.

If you plan on keeping the house, there are a lot of downsides.

With a regular mortgage, as you pay off the principle, the amount of interest that you are paying slowly decreases, and the amount of principle that you are paying off increases. This accelerates as you approach the end of the loan.

With a non-amortized loan, the amount of interest that you are paying doesn't decrease, and you have a lump sum at then end that you need to pay.

What does this mean?

for an 400 k amortized loan with 8.5% interest (current rates) making the minimum payment you pay:

2.9k a month.

A total of 1.06 million, or 656K in interest..

With a non-amortized loan you pay: 2666.667 a month, (it only saves you $268) or 1.36 million, with 960K in interest.

Now the S&P pays a 10% interest rate (on average) So you invest the difference monthly (most people who do this don't, that 268 goes straigth to other things. Its why the 2008 crash was so bad) which gives you a $316K return. Which means you are up 12K, not bad. But wait, over this time period you invested 96480 you now owe capital gains which comes to 26K, assuming no capital gains hike, You are now down 14k. Please note this assumes that you can keep your money in a risky portfolio up to the second you need it (a bold choice).

Whenever playing arbitrage games, you need to give the tax man his cut.

TLDR: Use current interest rates when making calculations, and always remember that the tax man is going to take his cut of the pie.

Using this website, I assumed that this arrangement saves me annually the equivalent of the principal repayments, which I could subsequently invest in something else during those 30 years.

Correct.

You need to religiously set aside the amortized interest into an account which you will use to pay the interest as a lump sum in 30 years.

Ideally, this would be a money market savings account or CDs for guaranteed ROI.

My question is, am I understanding this correctly? Are there potential benefits / drawbacks that I am missing?

Assuming the loan has no shark-ish strings attached then the should be no monetary drawbacks.

The biggest pitfall is simply you not having the lump sum ready for payment at the end of the loan. The reason behind your failure to save that money is none of the bank's concern; you promised you would have it.

So if you're not a responsible saving/investment person then you will cause your own problems by getting this type of loan.

United Kingdom context: it is possible to take a tax free lump sum from your pension pot when you retire. If you go for this type of mortgage, the monthly repayments are lower, and you can invest the difference into your pension, which you can do from your gross pay, up to a fairly high lifetime contribution limit.

This effectively allows you to buy a house largely from untaxed income, provided that your pension lump sum plus other savings are sufficient to pay off the mortgage.