Interest Only, Interested?

Do your know anyone who wants lower monthly payments?  They have a better chance today than has ever existed. Not only are interest rates at 40-year lows, but there is also a new mortgage-financing program that can lower payments even more. "Interest only" loans are now available.

Who's a candidate for this type of loan and what are the benefits? This loan is especially suited for individuals whose income varies from time to time (such as commissions, bonuses, or irregular payments). With "interest only," the obligation is to pay the interest portion of the loan, and pay principal when it is convenient. Paying principal is not required, but is recommended since reduction in a loan balance grows equity in a property.

Is principal reduction really necessary?  Not for everyone.  If the intention is to sell a property in a few years, principal reduction may not be recommended. In our area, we have generally enjoyed appreciation in property values; therefore, the property may become more valuable without reducing principal. "Interest only" loans eventually require payments of principal, but that varies from lender to lender.  It is best to compare these requirements since the "interest only" period can vary from -1 to 10 years. The loan is typically a 30-year term loan, with a certain period of time where "interest only" payments can be made.  Afterward the unpaid principal balance is amortized over the remaining term to include principal and interest sufficient to repay the loan in full.

These loans are available on all types of mortgage loan programs.  Primary residences, second homes, and rental properties can be financed.  Stated incomes also may qualify.  Rates do vary from lender to lender and are based on the same factors as any other loan type, such as credit scores, loan-to-value ratios, documentation type, financial reserves, and monthly debts. Some lenders will charge a slightly higher rate for the "interest only" option, so be sure to ask about this before you or your client applies for a loan.

How much does the "interest only" option reduce your payment?  Let's assume a mortgage loan amount of $500,000 at 6.50% interest.  A regularly amortizing loan would have a monthly payment of $3,160.34.  With the "interest only" option, (at 6.25%), the monthly payment would be $2,605.16. This is a saving of $555.18 per month.  Plus, with the lower payment, the borrower can qualify for a higher loan amount if necessary. This represents savings of over $6,662.00 a year.  BUT REMEMBER, the principal is not being reduced and remains at $500,000, so equity in the property is not occurring at the same pace as an amortizing loan.