Interest Only Loan

[cabledude]

Just looking around and sucking up information. Heard about a interest only loan. Definetly better payments, but in what situation would this be a good choice? Sounds to me like a scam to get you in a bigger house than you can afford? Looks like cheap rent to me with all of the headaches of home ownership?

[amortgageman]

If an interest only loan is abused, then yes, it is nothing more than glorified rent payments, with the reponsibilities of home ownership. It would be about the same as making minimum payments on a credit card.

I could sit here and write a book about the advantages of using an interest only mortgage, but this usually only works if the ideas are implemented to fully cash in on the benefits.

1) An interest only first mortgage payment difference can allow the homeowner to expedite paying off a second mortgage (at higher interest rates) faster, so that all that is left is a first mortgage. Planning is crucial to long term rewards.

2) Maybe someone has seasonal spikes, commission, bonuses, etc., in income, this could help balance the payments in leaner months, made up by paying extra during good months.

3) Some will have college funding to send their kids to school. An interest only mortgage can free the parents of additional obligation as compared to an amoritizing mortgage.

4) Maybe the homeowner wants to accelerate their retirement savings, yes an interest only mortgage can help them contribute more to a retirement account, while still reaping the benefits of homeownership.

5) Younger generation, who expect their incomes to increase over the next five to ten years, can benefit.

6) If the home appreciates in value, then look at two homes. One at $200,000 and one at $300,000. An interest only payment may allow the homeowner to afford the $300,000 purchase, instead of a $200,000 purchase. Now let's assume a 6% increase in housing prices. At the end of year one, the homeowner with a $200,000 home will have gained $12,000 in equity, while the homeowner with a $300,000 home gains $18,000 in equity. Keep compounding these numbers out for 10 years and tell me who made out better. Add to this the amount of savings on a $300,000 loan could be around $300.00/mo. If that money were to be invested for the ten year interest only period, then with zero return on the investment, the homeowner will have already put $36,000 in a bank account. Pretty savvy, if done correctly.

7) Like I said in the beginning I could go on and on.........and I have only covered the most basic of these plans.

In my opinon, it is pretty worthless to tie into an interest only loan for a temporary loan at 100%, on a short term 2/28 loan or a 3/27 loan when the homeowner will NEED to refinance in two or three years, does not have the sense to make extra payents or save, but will need equity to help pay for the refinance. Could be a disaster there.

Same thing for going way out over the homeowners means to pay for a home loan. After ten years, there will be two choices, move or pay off he loan according to a twenty year amoritization schedule.

Another good example of a NOT, would be paying MI insurance and not paying off any additional principal.

Also interest only loans do not provide adequate benefits in transactions less than $75,000 ($60.00 less per month)- $100,000 price range. As a matter of fact, some lenders will require at least a $100.00/mo difference before they will allow an interest only loan.

[cabledude]

Thanks for the great information. Sounds like if you do it for the right reasons it might just make sense.

[Xanathos]

OK let me ask you this (because I saw that ad for Quicken loans the other day and went "hmmmm").

Let's say housing values/prices in the area are skyrocketing (12% increase this year alone). Let's also say that there exists a very real possibility of a move in the near future to another part of the country, and we want to keep the house because of said property value boom. I know we're getting some sort of a writeoff at the end of the year on the interest we're paying for this house now.....

Would we come out ahead overall if we transfer over to one of these interest only loans and basically just sit in stasis with total amount owed on the house while we let it build up value? We can't afford to just let it sit...and we'd really rather lease it to friends we know will take care of it than strangers who can afford our mortgage payment yet for some reason can't buy their own home...but said friends would only be able to afford an interest rate tally.

We don't really have housing upkeep worries--everything is modern, and we're not prone to hurricanes in the mountains of Central Oregon ( ). Our property taxes are absolutely insane (Oregon has the highest in the country, and our county has the highest in Oregon), but that's really about it.

[amortgageman]

Xan,

One of the most important questions regarding refinancing, is how loanag it will take to recuperate the costs of refinancing. This timeframe needs to be calculated before any final decisions and papers are signed.

To calcuate an interest only payment, take the interest rate on the note (Say 6%), divide by 12 (monthly payments) and multiply by the amount of the loan. I.E. (.06/12 = .005 * 100,000 = $500.00 per month). The interest only savings vs. a fully amortizing loan is about $100 per month per $100,000.

There are also interest only loans available on five year fixed terms with even lower interest rates, as well as some three year products in the low 4% range. Please be careful with these because they ar designed more for specific need. (For instance a three year loan, when you plan on selling the home within three years).

Another consideration, if property values are rising that fast, could possiby be a negative amortization loan (i.e. 1.25% loans). These products allow a minimum payment at the 1.25% rate, (very low minimum payment), but carry additional risk. When the negative amount of the loan reaches a value of 110% of the original loan amount, these loans automatically convert to a fully amortizing loan, and the payments will skyrocket. The one advantage to these loans is that you are allowed four payment choices, or a payment amount you select. Interest only payments will prevent negative amortization, but here again, if you only make the minimum payment, can spell trouble.

Interrupted, will continue later.

[liverichly]

Who Benefits from Interest-Only Loans?

Borrowers making successful use of interest-only loans tend to be savvy with their money management, have good credit and have better uses for their money than paying off a 6% fixed-rate mortgage.

An interest-only mortgage might be a good fit for:

someone whose income is mostly in the form of infrequent commissions or bonuses;

an entrepreneur or salesperson who is subject to seasonal or short-term interruptions in cash-flows and wants to minimize outlays in the interim;

a homeowner who expects to own their home for a short time period, say three to seven years, and is content to build equity through market appreciation rather than by paying down the mortgage;

a disciplined investor who will use the savings (which can be hundreds of dollars per month) on the difference between an interest-only mortgage and an amortizing mortgage, and who is confident that the investments will make money.

If there were such an animal as a typical interest-only borrower, it would be an executive who earns a moderate salary and whose main income is from bonuses once or twice a year. An interest-only mortgage would provide the lowest possible monthly payment for lean months, yet allow the executive to pay down big chunks of principal when bonus time rolls around.

Business owners or commissioned salespeople with unpredictable incomes might benefit from interest-only mortgages, too. They may need to minimize their monthly outlays during seasonally or temporarily lean periods. Unless their loan has a prepayment penalty, they have the option of making unlimited principal contributions when cash-flows improve.

For much of the past twenty years, homeowners in most U.S. markets would have seen their home equity grow faster through home appreciation than through amortized mortgage reduction. Many homeowners who don't plan to stay in their home for 30 years have concluded that they can make better use of their money by NOT paying down the mortgage. They have adopted what some refer to as a "mortgage rental" strategy (as opposed to the traditional "mortgage reduction" strategy).

Financial advisers recommend interest-only mortgages to borrowers who have a sound strategy for investing the savings. Whether funding college savings for their kids, retirement plans for themselves or accumulating savings to meet other financial goals, money traditionally spent to pay down a mortgage may be better invested outside the home. As detailed in the book "Missed Fortune" by Douglas R. Andrew (Warner Business Books, copyright 2002-2004), proper repositioning of home equity can help homeowners attain financial independence. Andrew, and other like-minded financial advisors, argue convincingly that interest-only mortgages are key to managing home equity successfully to increase liquidity, safety, rate of return and tax deductions.

Key Interest-Only Loan Risks

With an interest-only mortgage loan, you pay only the interest on the mortgage in monthly payments for a fixed term. After the end of that term, usually five to seven years, you either refinance (often into another interest-only mortgage), pay the balance in a lump sum, or start paying off the principal, in which case the payments rise significantly.

Borrowers who are not prepared to be disciplined about investing the principal-savings associated with an interest-only loan should weigh the following risks before opting for this type of home financing:

minimum loan payments rise significantly when the interest-only period ends and amortization begins

interest rates on the loan fluctuate either from the start or when the interest-only period ends

principal savings diverted to "frivolous" expenditures can consume, rather than reposition, equity

Unless you refinance into another interest-only loan, the savings are temporary. If you're still in your home at the end of the interest-only period, you'll have to start paying off the principal. You could experience payment shock. Your monthly payment will go up, sometimes by 30% or more, because your loan balance will be amortized over a shorter period. For example, if your interest-only option lasts for five years and you have a 30-year loan, your principal payments will be calculated on a 25-year term.

As described in the next section, your interest rate either fluctuates monthly, or is fixed for a period of 6 months or 1, 3, 5, 7 or 10 years. Changing monthly or introduced at the end of your fixed-rate term, your new interest rate will be calculated based on a variable index plus a fixed margin, which combined could cause you to experience a rate rise. If the end of your interest-only period coincides with an upward adjustment in your mortgage, you could face an even higher increase in your monthly payment.

What if you spend your monthly savings to buy a new boat or car or take a grand vacation, and haven't put the money into some type of savings account? You are then more vulnerable if your home value declines. Many borrowers with interest-only loans assume home price appreciation will help them build equity in their homes. In recent years, that's been a good bet: Average home prices have risen 42% since 1999. But rising interest rates could deflate real estate values in some high-cost areas. Equity, either repositioned or tied up in the house, provides a cushion against falling home values. Without it, you could find yourself owing more on your mortgage than your home is worth. If you sell, the proceeds won't cover your loan balance, which means you'll have to come up with money from a source that was intended to meet other financial goals.

[firstsource]

GREAT POST.

Thanks for your post.

It says clearly what a lot of loan officers would like to say.

I/O loans are good for a few people and a few circumstances.

Charles

[amortgageman]

Charles,

It says clearly what a lot of loan officers would like to say.

So, I stutter when I type. Or is that what you meant to say?

I/O loans are good for a few people and a few circumstances.

Actually, I think they are good for a lot of people, in a lot of circumstances. The biggest issue is training the users of these loans in the benefits, and how to use the benefits to the best of their ability. Until that day comes, when the homeowners are educated, can they fully utilize the benefits of these loans. They are not for everyone, just like credit cards should not be placed in some peoples hands, and there is alot that goes into these loans. Financial responsibility is a must, short term and long term goals need to be identified beforehand, and a plan has to be made, all the way into retirement age.

They are not for everyone, just like credit cards should not be placed in some peoples hands.

Speaking of, the Chevy Chase account Exec just came through the door.

[firstsource]

Actually, I have watched you type, and I think that you do stutter.

Hope you got some great pens with blue ink....

Charles

[new2this]

Would this type of loan also be good for a person looking to quickly "flip" the property?

K