Wednesday, April 19, 2006

Interest Only Mortgages and Loans

Interest Only Mortgages and Loans

Until recently the Adjustable Rate Mortgages were one of the most popular mortgage types. However with the recent rise in interest rates the difference between an adjustable rate mortgage and a fix mortgage has diminished. As a result of this many borrowers are turning to interest only mortgages looking for ways to reduce their monthly mortgage payments.

How does an interest only mortgage work: An interest only loan allows you to lock in a fixed interest rate for the term of the loan and pay interest only for the first 10 to 15 years of the loan. Interest only home loans are a relatively new product which really didn't even exist 2 years ago. After the initial period of interest only the monthly payment jumps up so the borrower can repay the loan over the remaining term. Effectively you are converting your interest only loan into a 15 or 20 year conventional loan because to have to payoff the mortgage in the remaining years of the loan.

Disadvantages of interst only mortgages: First of all as the name of the loan says it is an interest only loan and therefore you will not be building up any equity in your house except for the potential increase in the value of you home. Secondly, many borrowers may go into payment shock when the intial period ends and you have to accept the higher monthly payments. However, you can always refinance the loan into a new loan when that time comes. However, remember you are starting at ground zero. You have not paid anything off on the balance of your mortgage debt. To address this problem if you do select this type of loan you should make principal payments on a regular basis to help work down the principle on the mortgage. Bankrate.com has an interest only mortgage calculator that allow you to calculate the payment. Make sure you compare the payment on an interest only loan to that of a fixed rate loan to understand exactly what the difference will be.

Examples: Below I have compared the monthly payments for an interest only mortgage loan compared to that of a fixed rate loan. I have assumed a $150,000 loan for 3 years.

  1. Interest only loan payment: $656.00 per month
  2. Conventional 30 year fixed: $936.00 per month

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1 comment:

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