How does an interest only loan work? - Over the past couple of year interest loans have become immensely popular due to the lower monthly payments. In some cases such as as skyrocketing home prices on the east coast and west coast have forced buyers to get interest only loans just to qualify for the mortgage payment.With most interest only loans, you can pay as much over the interest only payment each month as you would like. Anything that is applied above and beyond the interest only payment each month will be applied directly towards the principle balance of your loan. Interest only loans provide borrowers with some extra flexibility with their finances each month by providing borrowers with a very low monthly payment.
A new program that is gaining in popularity is the 10/30 Interest Only mortgage. This mortgage has a interest only period of 10 years, after which it switches the a standard 30 year fully amortized mortgage. This loan combines the flexibility of low monthly payments with the security of a long term fixed rate mortgage.
Interest only loan programs are offered on fixed rate mortgages, adjustable rate mortgages, or on negative amortization mortgages. The biggest misconception is that borrowers on an interest only loan are given the option to pay "interest only" where the borrower pays only the interest portion of the monthly payment for a fixed period. At the end of that period your loan becomes fully amortized.
Choosing a loan with an interest only option will usually add .25% - .50% to the interest rate.
Consult with a licensed loan officer to determine if interest-only loan is a right loan for you. Compare the payments on the interest-only loan against other alternatives such as the loans with longer amortization periods such as 40 or 45 years.
Interest Only loans should not be confused with negative amortization mortgages, as there is no way to increase your principle balance provided you make your payments on time every month.
This difference in savings from making principle payments can be used for other things like paying off consumer debt or unforeseen expenses such as medical bills or a loss of income.
Interest-only loan - It’s a mortgage loan that is structured so that the borrower pays only the interest due for a certain amount of time; for example- three, five, seven, or 10 years. After the interest-only period has expired, the loan is renegotiated at the current interest rate for the remaining life of the loan. For example, if the loan were set up as a seven-year interest-only loan, the borrower would pay only interest for the first seven years. At that time the principal would be amortized over the remaining 23 years of the 30-year loan at current interest rates.
Borrowers should always keep in mind that the interest only payment feature is an option. The borrower always is able to make payments towards principal reduction (within the parameters of any pre payment penalty restrictions) if they choose to do so. This is why an interest only feature is attractive to borrowers with fluctuating monthly income or who are self employed.
Interest only loans are great for self-employed and commissioned borrowers. Interest only loans provide more flexibility in making your monthly mortgage payments. For self-employed and commissioned borrowers this gives them the ability to pay more than the interest only payment when they have good months, and to pay the minimum interest only payment during slower months.
Interest Only loans are a compelling and attractive option for first time home buyers and borrowers whose incomes are increasing quickly every year.
One look at an amortization table from your lender is often all the reason a borrower needs to go the interest only route for 1 to 5 years, as in a classic principal & interest mortgage only a very small amount of principal is paid off in the same time period, and the money saved by the interest only borrower each month often can be much more useful in the borrower's pocket instead of the bank's.
Interest Only mortgages allow a home buyer to qualify for a bigger home with his current income. This interest only feature is useful for those who expect to have an increase in salaries and those who have other uses for their income.
Borrowers may want to look at the side by side comparison of an interest only loan compared to a regular Principal and interest payment loan and make a plan as to what they can do to productively make use of the difference such as investing or paying down higher interest debt.
After the fixed period of interest only payment, usually 5 or 10 years, the loan will be recasted into either 25 year or 20 year loan. The borrower needs to be careful and plan for the payment shock once the loan is recasted.
