A variation of the interest-only loan is the interest-extra loan. This type of loan can act as a principal reduction loan while reducing your payment. With an interest-extra loan, you pay a fixed amount each month on the principal.
Example: You have a $100,000 loan, with your first payment of
$1,000 allocated $900 to interest and $100 to principal. Since you reduced your principal by $100, you now owe $99,900. Your second payment would be $100 toward principal and slightly less than $900 in interest, since you now owe $99,900 instead of $100,000. The payment would continue to fall, since each monthly payment would be based on what you owe, not what you originally borrowed.
The loan works best if you pay a large amount per month toward the principal. Since you are reducing your principal amount quickly, you are correspondingly reducing your interest quickly, and thus, your total payment quickly.
This type of loan is ideal for borrowers with good present income that is expected to fall. A working couple that expects one or both of them to retire in ten years would be good candidates. By the time they face lower incomes, their mortgage payment would be substantially lower. They would not have to refinance in order to lower the payment. Unfortunately, this type of loan is not offered by your average lender.
This loan is simply a variation of the commonly used interest only loan. The difference is that with an interest-only loan, the borrower can only reduce the principal by voluntary payments in excess of the required payment. The interest-extra loan requires a payment higher than interest-only, forcing the borrower to reduce the principal. You may be able to create an interest-extra loan by asking your lender to take an additional amount above interest only as an automatic withdrawal from your checking or savings account if your loan is set up for automatic withdrawals. This will reduce the interest amount each month. Your best chance to do this is with a bank or credit union.
If your lender cannot or will not do this, you will have to voluntarily pay the additional amount with each payment.