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Interest Only Mortgage Loans

Mortgage Library: Types of Mortgage Loans: Interest Only Mortgage

The loan product commonly called 'Interest Only Mortgage' is an interest-only payment option which is offered on fixed rate (FRM) or adjustable rate (ARM) mortgages or on option ARMs. The option to pay 'interest-only' lets you pay only the interest portion of your monthly payment for a fixed period (three, five, seven or ten years). At the end of that period your loan becomes fully amortized, thus resulting in greatly increased monthly payments. Your new payment will be larger than it would have been if it had been fully amortizing from the beginning. The longer the interest only period, the larger the new payment will be when the interest only period ends.

Example

If a 30-year fixed rate loan of $350,000 at 7% has interest only payments for 5 years, the payment during the interest only period is $2,625.00. Starting in month 61, the payment is $3,180.51. The fully amortizing payment (the payment that, if maintained over the term of the loan, will pay it off completely) would be $2,993.86. So in order to reduce your payment by $368.86 for the first 5 years, you pay an additional $186.65 for the next 25 years.

Interest only payment plans are for borrowers who expect to earn a lot more in a few years and want to maximize their buying power now or who will invest the difference between an interest only and an amortizing mortgage payments, and who are confident that these investments will make money.

Advantages

+ During the interest only term your monthly payments are as low as they can possibly get;
+ You can qualify for a larger loan amount, maybe even a larger home;
+ During the interest only term you won't pay out cash to build equity;
+ Make investments with payment difference to potentially build your net worth;
+ The entire monthly payment qualifies as tax-deductible interest during the interest only period.

ARMs with Interest-Only Payments

Interest only payment options are typically offered on adjustable rate mortgages.

Payments made during the initial interest only period are based on the interest rate and loan balance and are applied towards interest only (they will not reduce the principle balance of your loan). Please note that the initial interest rate for the loan is established by your lender based on market conditions and may be lower than, or higher than the rate that is based on the index used to make rate adjustments. 

After the initial interest only period the loan converts to a traditional ARM: monthly payments are based on the interest rate, loan balance and remaining loan term and are applied towards principle and interest. The interest rate will be adjusted periodically based on the index rate plus a margin (your rate will be equal to the index rate plus the margin, rounded to the nearest one-eighth of one percentage point, unless your interest rate cap limits the amount of change in the interest rate).

How to Locate a Mortgage Professional Offering Interest-Only Loans

If you are looking for an interest-only loan and need more information or advice, we invite you to take advantage of our database of the most competitive lenders available. Just complete a short loan request form and the best lenders in your local area offering interest only loans will contact you with their rates and fees.

Where to Get More Information

Interest-Only Mortgage Tutorial
This article explains how interest-only mortgages work and some of the risks and advantages to borrowers that they introduce.

Option ARMs with Interest-Only Payment Options
The main advantage of this type of loan is the flexibility of making one of several possible payments on your mortgage every month, in order to better manage your monthly cash flow.

Pay Option ARM Calculator
Computes interest-only, minimum and fully amortizing payments.


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