Pros and Cons of Interest Only Loans
Interest only loans can be an excellent choice for some borrowers, however, you should be aware of both their pros and cons. They are designed to offer the lowest payment possible as you are not paying anything toward the principal in your normal monthly payment. Because of the lower payment, the interest only loan may mean that you can buy more home than with a fully amortizing mortgage. Of course, you may make additional payments toward your principal balance at any time.
The interest only loan was originally designed for individuals whose income is cyclical. For example, an individual who is a sales executive with a relatively low base salary but commission or bonus payouts quarterly would benefit from an interest only mortgage. You would have the lowest possible payment during months when no bonus is paid and you would be able to make contributions to the principal balance when the quarterly bonus is paid. However, I am seeing individuals in many situations choosing this option as a method of lowering their payment, sometimes significantly.
Generally, interest only loans are available for a 30 year term, with the first 5 or 10 years interest only (depending on the lender selected) and the final 20 to 25 years fully amortizing although I am now seeing some progressive lenders offering this option on ARMs. Some lenders who offer an interest only mortgage require a prepayment penalty for the first 1-3 years and have caps on the amount your rate can change at any time and over the life of the loan. I always try very hard to avoid prepayment penalties on these and other types of loans and can usually work around the requirement. Another useful feature of some interest only mortgages is that if you choose to make a principal payment during the interest only period, your balance is reduced the following month lowering your payment further. One thing you should be aware of is that at the end of the interest only period, the loan will become fully amortizing for the remaining period. For example, if you had a 5 year IO period and did not reduce your principal you will have a larger payment due to the fact that the loan balance will need to be paid off during the remaining 25 years. I always try to match my client's interest only period to the time they expect to remain in the home or mortgage to avoid the problem.
Again, an interest only loan is not the right choice for everyone, but it can be a very effective choice for some individuals. Please give me a call or send an email and I will be happy to discuss this alternative with you.
An example of how powerful this tool can be:
If you want to make the comparison for your own specific situation, calculators to find the amortizing payment are available on this website. The math to find the simple interest payment is, Loan Amount x Interest Rate / 12.
Many lenders offering interest only mortgages are now basing them on the LIBOR Index. There are many variations of this important product group. Read more about Libor ARMS.
Of all of the interest only programs available, the Cash Flow Loan offers the greatest flexibility by far.
As a Certified Mortgage Planning Specialist, I offer an analysis of your situation today can make suggestions on how small changes in how your consumer and mortgage debt is structured today can have a life changing effect in the years to come. Read more about this free, no obligation service.