Tuesday, January 04, 2005
Interest Only Loans, why are they so popular?
First let's cover the basics of an interest only mortgage. As the name suggests, you are only required to pay the interest on your loan each month. Interest only loans only behave this way for a fixed period of time (usually, but not always, 5 years). Example: You have a 6% interest only loan for $150,000. Your yearly interest is $9,000 ($150,000 x 6%). Your monthly payment would be $750 ($9,000 yearly interest divided by 12 months). After 5 years of payments, you would still owe $150,000 because you were literally paying "interest only." No part of your monthly payment was going towards principal.
Why choose an interest only loan? First of all, the same payment buys a more valuable house with an interest only loan than it does with a fully amortized (meaning the loan will be paid off over time) loan. By owning a more valuable home, appreciation will be magnified. Or, an interest only mortgage could provide a lower payment for a house of the same value when compared to fully amortized loans. This allows people to pay less monthly and use the extra money for savings, investing, etc. These points are especially important to a real estate investor, but also important to the average homeowner as they become increasingly financially savvy.
Sounds great, why wouldn't I choose an interest only loan? Interest only loans can be more complicated or risky than conventional fully amortized loans, which scares many people. Many times, interest only loans are adjustable rate mortgages and sometimes the fixed portion of the ARM and the fixed period of interest only can be different lengths. Also, when you have an interest only loan for 5 years, you still owe the exact same amount after five years. This can be disheartening to a lot of people. The general rule of thumb is similar to that of ARMs. If you plan on being in your home for an extended period of time (6-7 years and beyond), you may want to go with a fixed product and lock in a low rate for the life of the loan rather than an interest only product. This is not, however, set in stone. Extenuating circumstances may make an interest only loan your best choice, even though you plan on being in your home long term. Example: You cannot afford fully amortized payments on the house of your dreams, but you expect to have a pay increase in a few years. Interest only loans would allow you to get into the house today and refinance in the future with your increased income. It is best to consult a mortgage professional if you are unsure about choosing an interest only mortgage.
Why choose an interest only loan? First of all, the same payment buys a more valuable house with an interest only loan than it does with a fully amortized (meaning the loan will be paid off over time) loan. By owning a more valuable home, appreciation will be magnified. Or, an interest only mortgage could provide a lower payment for a house of the same value when compared to fully amortized loans. This allows people to pay less monthly and use the extra money for savings, investing, etc. These points are especially important to a real estate investor, but also important to the average homeowner as they become increasingly financially savvy.
Sounds great, why wouldn't I choose an interest only loan? Interest only loans can be more complicated or risky than conventional fully amortized loans, which scares many people. Many times, interest only loans are adjustable rate mortgages and sometimes the fixed portion of the ARM and the fixed period of interest only can be different lengths. Also, when you have an interest only loan for 5 years, you still owe the exact same amount after five years. This can be disheartening to a lot of people. The general rule of thumb is similar to that of ARMs. If you plan on being in your home for an extended period of time (6-7 years and beyond), you may want to go with a fixed product and lock in a low rate for the life of the loan rather than an interest only product. This is not, however, set in stone. Extenuating circumstances may make an interest only loan your best choice, even though you plan on being in your home long term. Example: You cannot afford fully amortized payments on the house of your dreams, but you expect to have a pay increase in a few years. Interest only loans would allow you to get into the house today and refinance in the future with your increased income. It is best to consult a mortgage professional if you are unsure about choosing an interest only mortgage.
