1. Interest only mortgages really get a bad rap when it comgees to talk about home loans. Many financial experts talk about how bad they are because you never gain any equity in the home because you are not paying down the balance. They are right in this conclusion because you are not required to pay down the balance during the interest only period of the mortgage.
2. What many financial experts or gurus do not tell you is that you have the choice to pay down the mortgage if you want. The mortgage company is not telling you that you have to for a certain period of time. Typically most interest only home loans are a normal 30 year fixed interest rate mortgage where the first ten years of the loan are an interest only option period and then at year ten it turns into a 20 year principal and interest loan where you would pay down the loan. Your payment will re-adjust to what the balance is at that time but the interest rate would never change.
3. The interest only home loan is not that much different than a normal 30 year conventional loan. For the most part they are both interest only loans. As an example, let’s take the normal 30 year rate as of July 29, 2008. The zero point rate is around 7.25%. On a 30 year fixed principal and interest loan a $200k loan at 7.25% would have a payment of $1,364. A interest only loan at the same interest rate would have a interest only payment of $1,208. As you can see there is only a difference of $1,364 – $1,208 = $156. Pretty sickening huh? Only $156 of your $1300 payment is going towards the principal balance of the mortgage or only 11% of the payment if you like looking at numbers in percentages.
4. From our example above, only $156 x 12 months = $1,872 would be going towards the balance in a year while $1,208 x 12 = $14,496 is going to the bank in interest. If that does not make you mad then I do not know what will not. You can see from these numbers that the majority of your payment is going to be going to the bank and you really do not start paying the balance down on the mortgage until year 15. Mortgages are set up to be a front loaded interest loan. This means that you pay more interest in the beginning of the mortgage than at the end. The banks do this so they can get their money up front so in case you default on the mortgage and they have to foreclose on you they would of at least made some money.
5. A number of people took out interest only home loans during the refi boom because they liked the lower payments. Some took out loans that were an adjustable rate mortgage and some took out ones where the rate was fixed forever. The people who took out the fixed rate loans are sitting in a good spot right now and for the most part even if you took out an adjustable rate one you should be okay too.
6. With all of the bad publicity about interest only mortgages its hard to not say to yourself why you shouldn’t get out of your loan. Here is the answer why you shouldn’t. If you took out a interest only fixed rate loan during the years of 2004-2007 you probably have a fixed interest rate between 5.5%-7%. Mortgage rates as of July 29, 2008 on a 30 year fixed are at 7.25%. Why would you increase your rate just so you are forced to pay down the balance? You won’t. Its one of the dumbest reasons to get out of a interest only mortgage. Every body is always looking for the lowest interest rate and guess what, you already have it.
7. The misconception about the interest only loan is that you never pay down the balance. Well, that is easy to take care of. When you get your monthly mortgage payment, get your check book out, add $100 to the payment and that’s it. The mortgage company servicing your loan will credit the $100 towards the balance of your home loan. That was not so hard was it? Do this every month and you will see your balance go down accordingly. Interest only mortgages are great for self-employed people, seasonal employees, sales people who are paid commission only, and anybody else who receives income that fluctuates over the year. When times are good, write out a larger check. When times are tough, write out just what you need to make the interest only payment. This way you are not getting any mortgage lates and your credit is still perfect.
8. The interest only mortgage is the best mortgage you can have especially if you took the fixed rate version. Sure, at year 10 your payment going to go up but that does not mean that it has to. using our example above of $200k at 7.25%, if you made the $1,364 payment to the mortgage every month your payment would never change. Now if you just made the interest only payment until year 10, it would re-amortize to a 20 year fixed principal and interest payment based on a $200k balance (remember that you just paid interest to your loan the last 10 years) at 7.25% it would be $1,580 a month. Your payment would go up $1,580 – $1,280 = $300. Its a decent jump in monthly payments. Many people prepare for this ahead of time by saving the $150 they were not paying towards the loan in mutual funds or savings account earning them a decent rate of return. You could have saved $150 x 12 = $1,800 x 10 years = $18,000. If you could even earn 5% on your money over those ten years you could earn an additional $6500 just in interest coming out to $24,500.
9. With all of the security of a fixed rate mortgage and the option to pay down the balance when you want why would you ever want to refinance out of a interest only home loan? You would not want to. Let’s say that even if you could find a deal where you could get a new 30 year fixed rate principal and interest home loan with .25 less in interest rate it would still not make sense to do. You would have to pay all of the closing costs (no such thing as a no closing cost mortgage) again and your payment would be higher than what it is. Same example as above: $200k loan, 7.25% interest only payment =$1,280 a month. $200k loan, 7% fixed principal and interest payment = $1,330. By doing so you are forcing yourself to pay an additional $50 out of your pocket and probably pay another $3000 in closing costs. Does not sound like a good idea with gas prices, food prices, and inflation as a whole is going up. Wouldn’t it be better to put that $50 in your pocket instead of using a credit card? I think so. A lot of home owners get themselves into trouble without saving up a lot of money and are forced to open up a home equity line of credit to have cash on hand in case of an emergency. If they had taken out the fixed rate interest only loan they could have saved the money from not paying down the principal and used it to pay for things. Now with the home equity loan they are paying interest on that now too.
10. One of the best features about an interest only mortgage is that when you do pay more towards your home loan the payment will re-calculate the very next month towards your new payment. On a normal 30 year loan the payment will stay the same regardless if you put $10k on top of the payment on any given month. Using our $200k example, let’s say you write out a check with $20k more on top of your interest only payment. The very next month your interest only payment will be based on $180k at 7.25% would be $1,087. Dropping your payment from $1,280 – $1,087 = $193 a month. Sure, its not a lot of money that it dropped but at least you can see some sort of dent in the payment. Think twice about refinancing your interest only mortgage. The majority of times you are in a better spot already then the one you would be in if you were to refinance into a 30 year fixed loan.