Can anyone tell me the difference between interest only and fixed rate mortgage rates?

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I heard a lot about the “value” of interest only mortgages, but I’m not 100% convinced that this is the right way. They say that people get loans with the interest and the rest of what you normally pay (the mortgage) in any kind of investment. If your mortgage like this, or if you pay the mortgage off quickly?

  1. Reply
    January 31, 2011 at 10:35 am

    if we are talking about the same type of loan, an interest only loan means you are only paying the monthly interest on the loan and none of the principle.

    So if you have a 100k loan you are just paying the interest rate on that 100k and not actually paying off any of the 100k. So your not really paying off your loan. In theory your only “renting” the 100k until you start paying off the principle

  2. Reply
    January 31, 2011 at 10:55 am

    If anyone tells you to get an interest-only loan, run away, and scream like a girl for effect.

    An interest only loan never pays down the principle. Which is bad in times like these, with the value of real-estate dropping. You can get upside down on the house pretty quick.

    Fixed rate means the interest rates never changes. If it’s 5% today, it will be 5% in 20 years. Your payment never changes.

    Adjustable rate loans stay fixed for a period of time, usually 2-5 years, depending on the loan, then vary annually, depending on the Prime Lending Rate. If the PLR is up, your rate will increase (the annual increase/decrease is capped at a couple of %, depending on the loan). Your payment varies.

    If you are buying a place that you will only have for a few years know this for sure), then an adjustable is fine. The initial rate is lower than a fixed rate, so your payment is less.

    I have gotten 4 mortages in my life. Everytime, I have gotten a fixed rate.

    Oh, just so you know, it’ll cost you $ 5,000 to close on the house. It’s called “closing costs” (for obvious reasons), and from my POV, they are a total rip-off. They make plenty on the interest of the loan, but I’ll stop before I start to rant.

    Good luck.

  3. Reply
    January 31, 2011 at 11:37 am

    Interest only mortgages are a good way for people to buy more than they could otherwise afford. HOWEVER, using this type of loan you pay only the interest on the amount borrowed and do not pay down the debt you’ve incurred. In other words, you don’t see the benefit of paying down the debt – you don’t gain additional value equity by paying off the loan.

    In an appreciating real estate market, and at the end of the loan term, you’ll have more valuable real estate but less to show for it. The entire amount of the loan will be due and you’ll only get the difference between the loan amount and the sale price. In a traditional loan you could take advantage of the market by paying off the loan AND realizing profit from equity buildup. In a declining market, you’ve lost money – from paying the interest on the loan and from falling real estate prices. Then what do you have to show for your investment?

    To the theory that you could invest your money elsewhere – that’s always an option. As an investor you have to determine where you will get the best return on your dollar. Traditionally, real estate doesn’t appreciate as quickly as other investment vehicles, however, it often doesn’t come with the risks of other investments. Only you can judge your tolerance to risk.

    Lastly, because real estate tends to be a stable investment, you would be better served to pay down the debt as quickly as possible. The number crunchers will often tell you that by making 1 extra payment a year on a traditional 30 year home mortgage will take 8 years off the loan. This more dependent on prevailing interest rates, but the end result is the same. You will see accelerated equity buildup and will lower your debt load over time. This is the best way to go, provided you can afford it.

  4. Reply
    January 31, 2011 at 11:45 am
  5. Reply
    Nick R
    January 31, 2011 at 12:04 pm

    Interest only loans are great loans if you plan to move within three years, providing you are living in a city with appreciating values.

    Example: $ 200k 30 fixed at 6 1/2% interest = $ 1264 +tax & Ins.
    $ 200k 5year arm 6% interest = $ 1000 + tax & Ins.

    On a fixed rate you are paying around $ 50.00 principal
    You could add $ 50.00 to your interest only payment which will apply the same amount of principal as a fixed rate and your still $ 200 a month ahead.

    Much depends on your credit score.

    As long as you do not have any prepayment penalities you sell any time you choose.
    You still get a great tax write off on the interewst paid, and you could get up to 30% back on your taxes.

    Have someone THAT KNOWS what they are doing show you paper.
    For the young buyer of today, its the best way to go,

  6. Reply
    January 31, 2011 at 12:09 pm

    Your payments will be higher and the loan will take longer to pay off

  7. Reply
    Aussie Bloke
    January 31, 2011 at 12:11 pm

    Think of it as rent. You are paying nothing on the principal of the loan – so the loan doesn’t actually get paid back. If you’re going to sell in the near future, this doesn’t matter too much, so long as the value of the property goes up. Over the long term, however, it will cost you a bundle more – these loans are not recommended for people who plan on staying where they are and putting down roots.

    I always pay on the principal as well as the interest – that way, I gain equity in the house. And that’s why, when I sell, I can afford to buy bigger houses in better neighbourhoods these days – that go up in value faster.

  8. Reply
    January 31, 2011 at 12:33 pm

    The only advantage is that you get to live in the house and have smaller payments at the start.

    In the long run you will pay much more for the house. The whole idea is that in the future you will be better able to make larger payments because you will have a better income. Sometimes this is true and sometimes it is not true.

    By the way. Almost any bank will agree to take an interest only payment on any mortgage loan if money get tight. So getting a standard fixed rate mortgage is the way that I have always gone. I’ve been fortunate not to have needed to make interest only payments but my bank made it clear that it would be fine with them if I had to.

  9. Reply
    Baked n Blended
    January 31, 2011 at 1:05 pm

    These were popular in high growth area’s (like Florida) and were for folks who wanted into the market at a reasonable cost. They then could flip the property and make a profit. The problem was/is if the market drops, your stuck with a property you can’t turn over (at a profit) plus you have no equity in it.

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