Interest Only Loan & Mortgage!?! *???

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Me and my fiance are looking to buy our first place 🙂 I am doing the research, and at a loss in regards to this. No website I’ve found give just STRAIGHT UP facts about this so I want to know…
What are the advantages and disadvantages to an interest only loan?
And how is this different than an interest only mortgage?
Thank you in advance! 🙂

  1. Reply
    April 29, 2011 at 8:56 pm

    In the United States, a five or ten year interest-only period is typical. After this time, the principal balance is amortized for the remaining term. In other words, if a borrower had a thirty-year mortgage loan and the first ten years were interest only, at the end of the first ten years, the principal balance would be amortized for the remaining period of twenty years. The practical result is that the early payments (in the interest-only period) are substantially lower than the later payments. This gives the borrower more flexibility because they are not forced to make payments towards principal. Indeed, it also enables a borrower who expects to increase their salary substantially over the course of the loan to borrow more than they would have otherwise been able to afford, or investors to generate cashflow when they might not otherwise be able to. During the interest only years of the mortgage, the loan balance will not decrease unless the borrower makes additional payments towards principal. It is important to note that under a conventional amortizing mortgage, the portion of a payment that represents principal is very small in the early years (the same period of time that would be interest only). Interest only loans represent a somewhat higher risk for lenders, and therefore are subject to a slightly higher interest rate. Combined with little or no down payment, the adjustable rate (ARM) variety of interest only mortgages are sometimes indicitave of a buyer taking on too much risk- especially when that buyer is unlikely to qualify under more conservative loan structures.

    Many homeowners saw the values of their homes increase by as much as 4 times its price in some markets in a 5 year span in the early 2000s. Interest-only loans helped homeowners afford more home and earn more appreciation during this time period.

    Don’t expect this appreciation anymore in most areas of the United States. Expect depreciation. Look into renting if you don’t have a large down payment to put down. Its still much cheaper to rent than own in many areas of the nation.

  2. Reply
    April 29, 2011 at 9:55 pm

    Loan and Mortgage are the same thing.

    On a mortgage you can pay principal (the amount of money you borrowed), interest (the amount/rate the bank charges you for loaning you the money) or just interest only which means your payment is lower than if you were making a payment on principal as well.

    Disadvantage is that you do not pay down principal with an I.O. loan. Personally, who cares if you aren’t going to live there for 30 years and/or refinance for 30 years..why get a 30 year loan. I.O.’s are the way to go in my opinion…

  3. Reply
    April 29, 2011 at 10:18 pm

    An interest only loan (or mortgage..same thing when you’re buying a house) is when you are paying only interest on a loan and not any money is going toward the principle amout. This is a good tool to use if you have bad (or subprime) credit. It gets you into a house and when your credit gets better then you can refinance for a better rate. Get somebody to tell you how to pay off a loan in half the time by paying more on the principle. Look at an “amorization schedule”. Google it and find examples to plug your own numbers into it. Look at the next month’s payment and see that when you pay the next month’s “principle” it will save you THOUSANDS over the life of the loan and you’ll pay it off in half the time without getting you financial butt kicked! : )

  4. Reply
    April 29, 2011 at 10:31 pm
  5. Reply
    April 29, 2011 at 11:08 pm

    Interest-only mortgage is the same thing as interest-only loan.

    Interest-only loans offer you a lower monthly payment, because no part of your payment is actually reducing the amount you owe. You are only paying the interest charges.

    So that’s advantage #1.

    Advantage #2, which is rarely used I’m guessing, is that your payment actually recalculates every month. So if you do make a principal reduction payment (pay off some of the loan), your future payments will be lower. This works well in some cases, like if you somehow land a big chunk of cash, or your income comes in big bonuses, and you can keep payments lower when you need it, and pay it down when you have extra cash.

    In most cases, your interest-only period lasts for 5 or 10 years, though sometimes on adjustable rates, it might be interest-only during the initial fixed-rate period only, like a 3 year fixed ARM that is also interest-only for the first 3 years.

    After that, your payments will jump up, sometimes substantially. If you haven’t paid down a penny of your loan for 10 years, you’ll typically have only 20 years left to repay it. That means, depending on the rate you have, a payment spike of 40-50%.

    For example, a $ 100,000 loan at 6% interest. For 10 years, your minimum payment, interest-only, would be $ 500/month. After that period, you’d have 20 years to repay the full $ 100,000, making your payment jump to $ 713. A 43.3% increase.

    A couple things make that not so important though. First and foremost: Most people refinance or sell their home within the first 5-7 years. It’s my understanding that over 90% of mortgages are paid off in full by a refinance or sale by the 7 year mark.

    Also, there’s inflation. If inflation is 2% annually, that effectively reduces the cost of the increase, by almost half. Simply because in 10 years, $ 500 won’t be worth what it was today.

    But again, there’s less than 10% chance you’d be in that loan in 10 years anyway.

    The reality is, most people take interest-only loans, and never add more. One nice benefit of a normal mortgage was, that eventually, hopefully, you’d be debt-free. This whole concept seems to have gone by the wayside over the past 5-10 years. Now it’s fashionable to take option ARMs that actually allow your mortgage balance to go UP every month, while you make a ridiculously low payment. Eventually, you might owe more than the house is worth. What happens if you have to sell?

    Go search for the housing finance agency for your state. Contact them, ask about first-time buyer counseling classes (available online as well as in person. Highly recommended!), lenders they work with, and any grants/subsidies/free money you might be eligible to receive.

    Good luck.

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