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An Interest Only Mortgage is a payment option that is offered on a fixed rate mortgage (FRM), adjustable rate mortgage (ARM) or option ARMs. The interest-only option lets you pay only the interest portion of your monthly payment for a set period of time, usually 3, 5, 7, or 10 years. Once this period is over, the loan becomes fully amortized, resulting in higher monthly payments. The longer the payment period lasts, the larger the new payment will be when the interest only period ends.
This is a great mortgage plan if you expect to earn a lot more in the near future and want the most out of your buying power. Some people will also invest the difference between an interest only and amortizing mortgage payments. If these investments do well, this is a wise decision.
These loans do not carry negative amortization, such as Option ARMs or Cash Flow loan programs. Some companies will carry Hybrid Interest-Only Option ARMs that can result in negative amortization.
Advantages:
- An interest only mortgage is appropriate for someone who earns wages in irregular intervals, such as commissions or bonuses, because it allows the borrower to invest his or her money in other things.
- Monthly payments are as low as they can get during the interest only term
- It is easier to qualify for a larger loan amount
- Monthly payment qualifies as tax-deductible interest during the interest only period
- Build net worth by investing initial payment difference
- During the interest only term, you won't have to pay out cash to build equity
- Great if you plan on selling a home quickly
Interest Only Mortgage Loans (Conforming):
Interest-Only Payment ARMs
Interest-only payments are applied strictly toward the back end and will not reduce the overall principle balance of a loan. The initial interest rate is established by a lender based on the index used to estimate mortgage rates.
Once the initial interest-only period is over, the loan converts to a tradition ARM. Payments are based on the interest rate, remaining loan term and loan balance, which are then applied toward principle and interest. Interest rates are subject to adjustment depending on the index rate.
Interest-Only Fixed Rate Mortgage Loans
Interest-Only Fixed Rate Mortgage Loans allow borrowers to lock in an interest rate for the life of a loan, while reducing monthly payments by paying only interest and no principal, normally for the first 10-15 years.
The problem is that payments made don't build equity in your home. Once the interest-only period ends you can be hit with much higher monthly payments and then have to pay the balance of the mortgage for the remainder of the term, usually 15-20 years.
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