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.
Pros and Cons Of An Interest Only Loan - As with everything else in life, there are pros and cons to every type of mortgage available. Your personal situation will ultimately determine what type of loan is right for you at this time, but if you are considering an interest only loan these are some of the pros and cons that you should be aware of.
With an Interest Only loan the interest rate is lower than with amortized loans. Which means it's your lowest payment option other than negative amortization loans.
Refinancing into an Interest Only loan is the best option if you're not planning to keep the loan for more than 5-6 years.
One con of an interest only loan is that your loan balance never decreases if you only make the interest only payment each and every month. Many consumers get into an interest only loan thinking they will pay extra money, above the interest only payment, each month when they can however they never pay anything extra and their mortgage loan balance remains the same. Most consumers find reasons each and every month to take the money they are saving and apply it towards buying new things and never actually use the savings to pay down their mortgage loan. This strategy can be extremely harmful in the long term and can negatively affect retirement planning strategies.
Savvy investors that prefer to keep their assets as liquid as possible should consider an interest only loan. An interest only loan will free up cash flow every month that can be used for other investments.
Interest Only Mortgages - How does an interest only loan work and why would I want a loan that I only pay the interest on and never pay down the balance? These are common questions asked about interest only loans everyday. An interest only loan is simply another option for consumers when they are dealing with a mortgage. There are fixed rate loans, adjustable rate loans, 30 year mortgages, 40 year mortgages, interest only home loans, etc... Interest only loans provide for a lot more flexibility each month in your monthly payment by requiring the borrower to only have to make the interest only portion of a mortgage payment instead of principal and interest. You are free to pay more than the interest only amount whenever you would like which will lower the principal balance of the loan and your home should always appreciate so you are still gaining equity in your home.
Interest-Only Mortgages are sometimes used by homebuyers to purchase a bigger home than they can otherwise afford. Because Interest Only home loans have monthly payments lower than that of fully amortized mortgages, homebuyers can acquire a mortgage with a higher loan amount.
An interst only payment may be a good option for those who are seasonally employed, self employed, or in commission based positions because it gives you the option to pay less when money is tight, and pay more when you have the ability to comfortably do so.
Interst only loans are also attractive to investors. The payment flexibility allows an owner to pay less if their property is not producing income.
However, on small loan amounts, an interest only payment may not be that much lower than a fully amortizing loan payment. Ask your loan officer to help you compare the two.
All interest only loans are interest only for a fixed period of time. (Generally 1-10 years, depending on the program) Make sure that the interest only option you are receiving will match your needs regarding how long you need the lower payment.
Interest-only loans also have some drawbacks. One pitfall is that attractive starting rates of interest-only loans may lure consumers into loans that they cannot afford long-term. For instance, once the "interest-only" part of the loan expires, say in five or 10 years, your mortgage payments can shoot up significantly, hundreds or even thousands of dollars more each month. Also, before the interest-only period expires, rates can increase, which will cause the monthly payment to increase.
Interest only mortgages can be very beneficial to the financially disciplined homeowner. Provided the homeowner can invest the equivalent of the principal payment that would be made on a fully amortizing loan and earn a return in excess of the after tax cost of interest the homeowner will come out ahead.
Fixed Rate Mortgage versus an Interest only Mortga - With a fixed rate mortgage (FRM), your monthly payments will be steady
Interest only loans are available with both fixed rates and adjustable rate mortgages. Paying the interest only allows borrowers to lower their monthly mortgage payment.
With an Interest Only loan, you make no payments to principle. They only way to gain equity is to make additional higher payments or choose a home in a high appreciation area.
In contrast, with an adjustable rate mortgage (ARM) , your payments will vary over time.
The average homeowner in America sells or refinances roughly every 5 years. Keeping this in mind, it may not always be in your best interest to go with a fixed rate mortgage for 30 years. An ARM loan may be more appropriate for you, especially if you know you plan on moving or refinancing within the first few years. A 5/1 ARM will generally provide a lower interest rate than a 30 year fixed rate mortgage will and the lower rate will equate to a lower mortgage payment. So think about not just the now when obtaining a mortgage but the near future as well.
Adjustable rate mortgages typically have an initial fixed rate lower than the rate of a comparable fixed rate mortgage. The initial fixed rate period is followed by adjustment intervals. For example, a "3/1 ARM" is fixed at an initial low rate for the first 3 years, and then adjusts every year based on an index. Common ARMs are: 1/1, 3/1, 5/1, 7/1, and 10/1. (Don't confuse ARMs and balloons )
Interest Only is an option that can be chosen for most types of mortgages, Fixed or ARMs. The interest only option allows the borrower to make only interest payments. This is usually only allowed for the first 5-10 yrs. Choosing an interest only option can also affect your interest rate. There is usually an add on of 0.25% - 0.5% to the interest rate for interest only payments.
Why pay interest only? - Paying interest only is a great way to minimize housing expenses per month. The concept of this type of payment structure is to allow you a set amount of time in which your payments will be based off of interest only. Every borrower should keep in mind that this loan will not pay down any of the principal balance during the interest only portion of the loan.
Why pay interest only - do you think you will ever really pay off your mortgage? How do you gain equity in your home? Is it from paying down your principal or moreso from the market appreciation of your home? When you consider these things paying interest only and having the extra cash flow often makes good sense.
Examine every loan option with your mortgage broker before you decide on a interest only loan program. Your mortgage broker will be able to determine if the interest only option is a good fit for you. This will ensure that you are not frustrated by an uninformed decision years down the road.
Many lenders charge a small premium in order to have interest only premiums, usually 1/8th or 1/4p point. Make sure you discuss this with your mortgage broker as well.
With an interest only loan you will still build equity in your home even if you only make the interest only payments and never apply any extra payment towards the principal. This is achieved because your house is always going to appreciate and gain value (unless you live in a community with declining home values, which is not very common). Therefore, You can still gain equity in your home while freeing up cash to pay down other bills, invest, and/or just to simply put save for a rainy day.
Many people choose interest only loans to increase their cashflow and not be encumbered by such a huge mortgage payment.
Feel free to contact us for a good financial advisor to seek which routes are best for you.
With any type of interest only loan you can choose to make additional payments to reduce your principal balance. These type of loans work very well with borrowers whose income may fluctuate on a monthly basis or borrowers who know they will be receiving a pay increase in the future and want to minimize the monthly payment until they have a larger income.
Interest Only loans allow you to purchase a larger house without increasing your monthly mortgage expense and it gives you mortgage payment flexibility to better manage your monthly cash flow without deferring interest.
Paying interest only may free up needed cash flow to help make payments on an investment property you may want to purchase.
Often times a real estate investor will want an interest only loan. The low minimum payments help to increase cash flow for other purchases.
The use of interest-only loans was unheard of just a few years ago, but in the last year these loans have exploded, giving many home buyers leverage against escalating home prices and enabling them to buy homes. A recent Wells Fargo survey of American homeowners showed that the majority of homeowners do pay principal on interest-only loans when they are flush with cash. 73% pay both the principal and interest at least some of the time. Only 25% pay only interest all of the time. Interest-only options on home loans give the home buyer the flexibility to choose how much to pay on their mortgage each month - just the interest-only payment or a little extra to pay down that principal.
Interest Only mortgages require monthly payment of "interest only" for a specified period, ussually the intial 10 years of a 30 year loan term. At the end of the interest only period, the loan is reamortized to pay off the mortgage in the remaining 20 years. The monthly payments will naturally be much higher compared to that of the interest only period. In practice, most homeowner refinance before the end of the interest only period. The disadvantage of Interest Only loans is in that the homeowner will not build equity during the interst only period. There is also the risk that the home has since lost value when it comes time to refinance.
Paying interest only may allow you to contribute to your 401k, or IRA retirement account, because of your new lower monthly payment.
Interest only loans can also be of value for borrower's seeking to consolidate other debt carrying high interest rates like credit cards. By minimizing your mortgage payment, you can afford to pay down these other debts more quickly.
