Interest only mortgages

[Triumph]

What's yinz's opinion on an interest only mortgage? Talked to a bank today about my options. The interest only loan is equivalent to a 7 year arm (interest rates, point deductions, rules at readjustment), and obviously you are paying interest only every month. BUT you can still pay against the principal. So for a person who is disciplined enough to pay against the principal on top of the interest every month, you are paying the same amount as a 7 year ARM, with the added benefit of a few hundred dollars a month that you don't have to pay should some situation arise.

Granted, it is not a large sum of money, not going to buy you a new car or something. But it looks to me like a free buffer for your mortgage every month if you are going to do an ARM anyway. Am I missing something here, some fees or tax reasons associated with interest only, that don't apply to a typical mortgage? I'm seriously considering it.

 

[Torghn]

Originally posted by: Triumph
What's yinz's opinion on an interest only mortgage? Talked to a bank today about my options. The interest only loan is equivalent to a 7 year arm (interest rates, point deductions, rules at readjustment), and obviously you are paying interest only every month. BUT you can still pay against the principal. So for a person who is disciplined enough to pay against the principal on top of the interest every month, you are paying the same amount as a 7 year ARM, with the added benefit of a few hundred dollars a month that you don't have to pay should some situation arise.

Granted, it is not a large sum of money, not going to buy you a new car or something. But it looks to me like a free buffer for your mortgage every month if you are going to do an ARM anyway. Am I missing something here, some fees or tax reasons associated with interest only, that don't apply to a typical mortgage? I'm seriously considering it.

(When) does the rate become variable? And what's it amortized over?

 

[Triumph]

When? After 7 years. Amortized? Well that's a good question, and something I need to ask.

 

[Torghn]

The 7 year arm will become variable after seven years, so it's a good option if you are going to live there for about 7 years. It's usually not very good if you are going to stay longer than that. Some interest only loans are fixed some are variable and some are fixed for a few years and then become variable. That's a very important part as you don't want it to go variable while you still live there. I guess Amortized isn't the right word as you only have to pay interest, so I should really ask when is the balance of the interest only loan due?

 

[farmercal]

I have a interest only loan on the percentage of money I couldn't come up with when I purchased my current house. The reason that loan works out for me is that because it is a second mortage I can deduct the interest off my taxes at tax time. If I didn't have that second mortage I would have to buy PMI and that is not deductable. Just made more sense and I am disaplined to pay more on it every month.

 

[sohcrates]

My second mortgage is interest only (it's a small 2nd trust instead of mortgage insurance since this is my first house).

we debated back and forth about interest only for our first (big) mortgage, but decided against it.

to me, it makes sense if you are

1) in an area where you know the house is going to gain value at least relatively quickly

2) are planning to move and / or refinance within about 3-5 years

It's not as terrible as everyone thinks, because like you said, you don't HAVE to pay just the interest.

Also, it's pretty much the only thing that will let you swing into a really expensive house if you don't have much down payment

 

[Vic]

Interest-only loans are ideal for borrowers who get paid on commission or are expecting to receive a large lump sum of money in the future (for example, buyers who still have their old home up for sale, but want to get in the new home right away). This is because, during the initial 10 year interest-only period, any prepayment of principal will reduce the monthly interest-only payments.
Any wage-earner or salaried borrowers who are considering an interest-only loan because they cannot afford the fully amortized payment should IMO not buy the house period.

Interest-only loans come in a variety of shapes and flavors. The one Triumph is referring to is called a 7/1 I/O ARM, or Hybrid 7 year fixed interest only adjustable rate mortgage with the remaining 23 years as a 1 year ARM. The market interest rates on that program are very similar to a traditional 30 year fixed fully-amortizing mortgage (though slightly less than a 30 fixed I/O). Other available interest-only programs are 30 fixed, 3/1 ARM, and 5/1 ARM, among others.

ALL interest only loans allow for an initial 10 year interest-only period, after which they fully reamortize for 20 years, for a total term of 30 years. During the interest-only period, any principal prepayments will reduce the amount of monthly accrued interest, thus reducing the monthly interest only payment. Also, during the interest only period, the loan is not amortized (or is infinitely amortized?) as you are making only interest only payments.

Make sense? 🙂


edit: Don't get me wrong. I/O loans are not bad. In fact, they're great. They're just not for everyone IMO. They work great for self-employed and commissioned borrowers who can fall back on the smaller interest-only payment during lean times and then make larger prepayments during the better times. They also work well for buyers still waiting for their old home to sell. When it does, and they apply the proceeds to the new mortgage, they get a lower payment without having to refinance. But if the only way you can afford the house is to go I/O, don't do it.

 

[Triumph]

The one Triumph is referring to is called a 7/1 I/O ARM, or Hybrid 7 year fixed interest only adjustable rate mortgage with the remaining 23 years as a 1 year ARM.

Does that mean that it will readjust every year for 23 years?

 

[Vic]

Originally posted by: Triumph
Does that mean that it will readjust every year for 23 years?

After the initial fixed period, it most certainly could, yes. Depending on the market conditions at that time. There will be caps, of course, both adjustment caps (the most it could adjust each year, usually 1-2%) and lifetime floor and ceiling caps (the lowest and highest rates possible during the life of the loan).
When shopping for an ARM, the initial fixed rate should not be your top concern. Instead, you should shop based on the margin, as the actual interest rate during the adjustable period is calculated based on an index plus the margin.