Interest only mortgage – Advantages/Disadvantages?

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The first reaction everyone has is no way, don’t do it. But, I’m going to be putting 20% down on the mortgage so I’ll already have equity in the property. My area is lucky in that home prices have only slipped maybe 1 – 2% in the past 6 months and are remaining steady if not increasing slightly. So appreciation will still be there since I’m figuring on being in the home 5 – 8 years. I’ll have the ability to control when and how much ‘extra’ I’d like to pay per month towards principal so I’ll still be building additional equity on top of the initial 20%. No prepayment penalty so I can refi anytime. And extra money saved on monthly payments can go towards home improvements which will increase the home’s value.

Just trying to research if there should be any reason why I would not go this route. Anyone who understands amortization of loans knows that you’re not putting that much towards principal anyway in the first few years of a 30 year mortgage.
Since some things are taken too literally: Of course home improvements never return a full 100% or anything near that, depending on what you’re doing. In my specific area there are improvements that can be made to properties that will increase the value (probably not 100% return) and also increase the demand for the property when it comes time to sell. The property that I’m planning on purchasing does not have this ‘add-on’ so that it what makes it currently less desirable and the payment flexibility will allow me to make these additions.

10 Comments
  1. Reply
    Matt K
    April 30, 2011 at 11:17 pm

    The only downside is that your payment goes to interest and that if real estate prices actually decrease, then you could end up with negative equity – but in your case that would be almost impossible since you are putting down 20%.
    Most people who get interest only loans don’t put down a lot of money.
    I totally agree with you about the amortization of a 30 year mortgage. You pay almost all interest for the first probably 10 years.
    Also, you can always pay extra towards the principal if you want to build more equity.

  2. Reply
    iwishiweresomewheretropical
    April 30, 2011 at 11:36 pm

    The homes value will not increase as much as the amount of extra interest you will pay. Any “extra” money will never get to the mortguage, because you will end up spending it, which you are already talking about doing! You do not reap 100% of the value back on home improvements. Refinancing costs money! Everyone is telling you it’s not a good idea, and nothing you say or think will change that fact. Learn the hard way if you must!

  3. Reply
    glenn
    May 1, 2011 at 12:33 am

    I think it is just a bad idea to not work toward reducing your loan amount. In your case it may work out fine, but what if you end up 20 years from now still in the same place and prices did not dramatically increase? If you are like most people you will never pay more toward your home than you are forced to.

    I bought my home one year ago on a 30 year fixed and only paid $ 1000 off this year. Next year it will be a little more and each year it edges up. On an interest only loan my payment would have only been $ 83 dollars less a month and twenty years from now it would still only be $ 83 dollars less a month with the only equity being my 20% down and the inflation that will likely (but not absolutely certainly) happen.

    I guess I am saying that the forced savings of even a small amount is appealing to me.

  4. Reply
    Mary B
    May 1, 2011 at 1:22 am

    Interest only mortgages are GREAT options, but ONLY for the disciplined borrower.

    It allows you to kick more money toward the principal each month than you would with a regular fixed-rate mortgage, with the security that you don’t have to make that high payment if you are having a financial bind that month…..but you MUST pay extra toward the principal.

    Statements of interest only loans are required to have an ammortized amount for a payment each month, to help you stay on track.

    The problem is that most borrowers find something else to spend their money on, and never pay anything extra towards the principal.

    That is when an interest-only mortgage is bad. They are very popular in California, where homes are so expensive, people can’t afford to pay anything more than the interest….but it also means that you will NEVER pay the house off.

  5. Reply
    loslunas87031
    May 1, 2011 at 1:59 am

    in a sense all you are doing is renting forever and never gaining anything with a tremendous security deposit that you could be making interest off of investing in another avenue

  6. Reply
    Quicken Loans
    May 1, 2011 at 2:58 am

    Interest-only is a great option. Try making one extra payment a year and you’ll start knocking away at the principal.

    Two things to be aware: no pre-payment penalties (which you mentioned) and don’t defer any interest (negative amortization).

    Other than that, you sound like a responsible borrower. Work on increasing the home’s value and keep an eye on home values in your area.

  7. Reply
    Tim
    May 1, 2011 at 3:37 am

    I have an interest only. We leveraged the house to buy rental properties and wanted a interest only as a safety net. Assuming the worst, rentals are un rented., we can afford the payment at interest only. When they are rented we can pay more towards the principal.

    Plan is to move in a couple of years and live in one of the current rentals. We got a 10 year interest only, which gives us an additional safety net of about 7 years longer than our plans.

    Have plenty of equity in current house, so when sold it will pay off loan, and rentals where paid through the loan. We’ll end up with multiple properties and no loans.

    For the right person and right reasons, interest only is a great choice.

  8. Reply
    Sophie Tucker
    May 1, 2011 at 4:11 am

    Interest only loans have to be paid off at some point, which is why after some time, your payment will increase to provide for the loan to be actually paid off. Imagine if you had a 30 year interest only loan. What would be your loan amount after 30 years? It would be the original loan amount you started out with. You can’t have that. So many people are losing their homes right now because their payments are resetting to higher rates which they can not afford. Get a regular fixed loan and be happy.

  9. Reply
    Lory R
    May 1, 2011 at 4:45 am

    An interest only loan works well for someone who plans to sell their home in a few years. The interest rates right now for conventional loans are at an all time low. There are many different loan options out there such as home ownership accelerators, ARMs, Hybrids, etc. I am loan consultant in San Diego and I do have some time to help you with this. Send me an email if you would like some one on one attention with this matter.

  10. Reply
    evensonhimself
    May 1, 2011 at 4:45 am

    i think you have show a strong point. however with putting 20 percent down you should be able to get a fixed 30 year rate right now down in the 5.625 ball park range, what kind of rate are you getting with your Interest Only loan? maybe the difference in payment won’t be worth going Interest only?

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