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Why all the Interest in Interest-Only Mortgages?
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A lot of homeowners in our area have opted for interest-only loans for their homes. Is this the right home loan for you? What is an interest-only mortgage loan anyway?
An interest-only mortgage is a mortgage where the borrower has the option of making interest only payments for a set period of time (say the first 10 years of a 30 year loan). Traditional mortgages require borrowers to pay interest and principal each month, but interest-only loans don't require that you pay any principal during the interest-only period.
Why would someone be attracted to this type of home loan? The simple answer is that the monthly payment is much lower. It's much lower because principal payments are not required (although there's nothing preventing you from making principal payments at any time.)
By and far most interest-only loans are adjustable rate mortgages (although interest-only loans can have an interest rate that is fixed for the term of the loan, such as a 30-year fixed mortgage). Because rates are lower on adjustable rate mortgages when compared to fixed rate mortgages, most interest-only loans also have a lower payment due to a lower interest rate.
Let's take an example. The monthly principal and interest payment for a 30-year fixed rate mortgage on a $600,000 loan at 6.25% is $3,694. The monthly payment on a $600,000 interest-only loan at 3.5% is $1,750. That's a savings of $1,944 per month!
So what's the downside? The simple answer is that by paying only interest, you are not paying down the principal. So, if your initial loan was for $600,000, you would still owe $600,000 if you made no principal payments.
But this isn't necessarily a bad thing if your home appreciates over time - and we've seen that indeed they do! Your investment (your home) will appreciate in value independent of whether you "sink" more money into your mortgage.
Again, keep in mind that you can make principal payments at any time. So if your compensation is cyclical (e.g. end of year bonus or commission) you can plan accordingly and make principal payments when, and in the amount that, you see fit.
Another benefit to these types of loans is that the lower monthly payment means that you can qualify for a larger loan and, in turn, a higher quality home.
The bottom line is that interest-only loans provide affordability and flexibility for those homeowners that want lower payments and the option of paying off the loan on their own schedule.
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