What Is An Interest-Only Mortgage and How Does it Work?

An "Interest Only" mortgage is a loan in which the scheduled monthly  mortgage payment ( the payment the borrower is required to make)  -- consists of interest only. As opposed to a typical mortgage with principle and interest payments, this type of loan keeps monthly payments to a minimum

For example, if a 30-year loan of $200,000 at 5.75 is interest only, the required monthly payment is $958.33. In contrast, borrowers who have the same 30 year loan but without an Interest only option would have to pay $1167.15. This is called the "fully amortizing payment" – the payment that would pay off the loan over the term if the rate stayed the same. The difference in payment of $208.83 is "principal", which go to reduce the balance.

With Interest only loans you do have the right to pay more than the interest only payment. If you choose the interest-only option every month during the interest-only period, the payment will not include any repayment of principal and the result is that the loan balance will remain unchanged.

The option to pay interest only typically lasts for a specified period, usually 3 years, 5 years, 7 years or 10 years.  After the "Interest Only" period is over, the loan payment changes to include principle and interest for the remaining term of the loan.

Although the typical Interest Only loan program is a feature of an Adjustable Rate Mortgage (ARM), we do  offer the interest only option on some of our Fixed Rate mortgage!!!!   

 Our Interest-Only ARM loans can minimize your monthly payments or maximize the amount you qualify to borrow. Here's how:

• During the initial fixed rate term of our popular 3/1, 5/1 7/1 and 10/1 ARMs, your minimum monthly payment will be interest only.
   
• After the three, five, seven or ten year initial fixed interest rate period, your interest rate will adjust annually based on either the 1-year LIBOR, T-Bill or CMT index, plus a margin.
   
• Because your initial monthly payments are set to equal only the interest on your loan balance, it will be less than a traditional amortizing loan payment for any given interest rate and loan amount.
   
• For this same reason,  the Interest Only loan amount that you can qualify for will be greater than with a traditional loan, and the full amount of your loan payment may be tax deductible (please consult your tax advisor).
   
• Once the interest Only portion of the loan has passed, your minimum monthly payment will be recalculated on each Change date to fully amortize your outstanding loan balance at the new rate over the remaining term of your 30-year loan.

Examples of Interest Only Savings:

# 1. Conforming Loan

Monthly Savings...............$ 167.15

#2. Jumbo Loan

Monthly Savings...............$347.84
 

For What Types Of Borrowers Are Interest-Only Mortgages Suitable?

Interest-only mortgages are for borrowers who have a valid use for a lower initial required payment, and if still in the mortgage when the interest only period is over are prepared to deal with the higher monthly payment. Here are some other excellent reasons to consider an Interest Only mortgage

Pay Principal When Convenient: Borrowers with fluctuating incomes may value the flexibility the IO mortgage gives them. When their finances are tight, they can make the IO payment, and when they are flush they can make a substantial payment to principal.

Buy More House: It is common for families to begin with a "starter house", then move into a more expensive house as their incomes rise. This process of "trading up" carries high transaction and moving costs.

You can avoid these costs by skipping to the second house now. In the short term, this will cause a cash flow strain, but the IO mortgage may make it manageable.

Invest the Cash Flow:   For most homeowners, paying down mortgage debt is the most effective way to build wealth. Nonetheless, some may build wealth more rapidly by investing excess cash flow rather than paying down their mortgage. For this to succeed, their return on investment must exceed the mortgage interest rate.

A valid example is the young borrower with a long time horizon who invests  in a diversified portfolio of common stock. This should generate a yield of 6% or more over a long period. Another are business owners who might earn a high return investing in their own businesses. 

Paydown or Payoff Credit Card Debt: Use the lower monthly payment  to help pay off your high interest credit cards.

Your "Best Interest" is Our Top Priority

Whether you want to maximize your loan amount or minimize your monthly payments, we can help you reach your goals.

To discuss Interest Only loan in more detail, call us toll-free 888-353-1558