How You May Be Able To Use The Interest Only Mortgage Loan To Your Advantage
By Joel M. Berinson (jb@ultra123.com) & Terrence J. Stafford (ts@ultra123.com)
October 2, 2007
One of the more talked about and discussed mortgage options over the last several years is the interest-only mortgage. Among the many different types of mortgage inquiries which we receive, interest only mortgage loans rank up there with the most popular - and for good reason.
While there are many different reasons for this loan program's popularity, most borrowers that choose interest only loans seem to gravitate toward their flexibility and enjoy the month to month cash flow savings that only the interest only mortgage loan programs can provide them.
With a traditional, fully amortizing, fixed rate or adjustable rate mortgage, a person would pay both principal and interest each month as part of their monthly mortgage payment. With the interest only fixed rate or variable rate mortgage, however - a person would be required to pay only the interest portion due on their mortgage each month.
(Note: To calculate interest ony payments on your own, please see the very bottom of our calculators page.)
To help illustrate the difference between a fully amortizing loan and an interest only mortgage let's consider the following example. Suppose that Kevin and Cindy are looking at refinancing out of their adjustable rate mortgage and into a fixed rate mortgage. One of their requirements, however - is that they would like to minimize their monthly mortgage payments as much as possible. Kevin and Cindy might compare these 2 options.
1. 30 yr fixed rate (fully amortizing) @ 6.5%
$300,000 @ 6.5% = $1896.35 (principal & interest)
2. 30 yr fixed rate (interest only) @ 6.75%
$300,000 @ 6.75% = $1687.50 (interest only)
If Kevin and Cindy choose the interest only option, which is option 2 - listed above, you can see that there is about a $210 "cash flow" savings between the 2 options. On a monthly basis they would realize approximately $210 in "cash flow" savings, which if carried out over 12 months would be roughly $2500 in this example. This "cash flow" savings comes about because Kevin and Cindy are paying only the "interest" portion that is due on the mortgage each month.
It is important to keep in mind that if Kevin and Cindy make their payment of $1687.50 each month, there would be no principal reduction in the outstanding principal balance owed on their mortgage. Their unpaid loan balance would remain virtually unchanged unless Kevin and Cindy opted to pay an additional amount (of their choosing) over the $1687.50 which is their minimum interest only payment due each month in this example.
In almost every instance, every $1 that Kevin and Cindy pay in addition to their minimum monthly payment of $1687.50 would be applied (dollar for dollar) directly to principal reduction. In this manner, the couple could essentially choose how they would like to pay down their mortgage loan, if they choose to pay it down at all. For example, if they wanted to paydown their outstanding mortgage balance by $500 this month, then they would need to send $1687.50 + $500 = $2187.50.
One must also consider the underlying value of the asset that the loan is secured against. The fact remains that the home is an appreciating asset. Historical evidence has shown us that our home's average annual appreciation is somewhere between 3-5% each year. So even though a homeowner may choose to make the interest only payments and direct no additional funds to principal reduction, the chance that someone would ever owe more than the value of their home is slim to none.
The interest only portion of these mortgage loans are usually available for the 1st 10 years of the loan's term. After the 10 year "interest only" period has expired, the loan is then re-amortized and paid-off over the final 20 years of the term with principal and interest payments. Depending upon the loan program (Fixed or Variable) the rate may or may not change during the course of their loan.
Although this option may not be available for everyone, the interest only home loan is an option that is extremely popular with those who have a distinct need to minimize their monthly obligations. These borrowers often have other circumstances in their financial plan that may warrant this type of mortgage strategy.
On the other hand, if someone is looking to pay down their mortgage loan as quickly as possible, there are better options available to them that should explore prior to making such a decision.
The other important aspect of this type of mortgage arrangement is that the interest only mortgage loan option is available in both the "fixed rate" and "variable rate" mortgage programs. Which option is a better fit for the borrower ultimately depends on a number of individual financial factors.
As always, should you have any questions about whether or not the interest only mortgage or any other type of financing might be a suitable strategy for you feel free to email us at: info@ultra123.com or you may give us a call.
