Debt Consolidation Depot
Debt Consolidation & Financial Information Resource Center
February 19, 2004
Tony Baricevic, Sr. Loan Officer, Amerimac First Mortgage, educates
readers about Interest Only loans. This article details what an interest
only mortgage loan is, how it works and why it is popular. It also provides
the reader with an objective examination of the pro's and con's of this
financing option.
(PRWEB) -- Interest Only loans gained widespread popularity in 2003 when
FannieMae, the largest purchaser of secondary market home loans, provided
guidelines to wholesalers for purchasing them. FannieMae calls it Interest
First also known as Interest Only option. Until recently, this type of loan
was common among seasoned investors who were looking for improved cash-flow
allowing them higher profit margins and freeing up reinvestment capital.
Interest Only options have also been available on 'negative amortization'*
loans also known as Fixed-pay, Option ARM or Cash-flow ARMs among other
names. However many Interest Only option loans like the FannieMae Interest
First do not have negative amortization.
How Interest Only Loans Work:
The loan can have an adjustable or fixed rate with an option to make the
interest only payment for a predetermined period of time, say five years.
Usually after that time, the loan payments become fully amortized and are
recalculated to pay off the loan in the remaining 25 years. This can result
in a significant increase in monthly payment if no principal has been paid
down over the Interest Only option period, unless you refinance. The
benefits of this loan are definitely cash-flow and it is also easier to
qualify, since the payments are significantly lower. It can also be a good
choice for people who are planning to sell their home in a few years, as
they will have had a significantly lower payment while possibly taking a tax
deduction of the mortgage interest. One risk involved would be if the value
of the property decreased when it came time to sell and they didn’t have
enough funds to pay off the loan.
Some common Interest Only option loans are; Fixed 15/15 Interest First which
has an Interest Only option for the first 15 years, or a Fixed 10/20 which
has a 10-year Interest Only option and then gets amortized over the
remaining 20 years. There are also adjustable loans like a 5/1 ARM with a
5-year Interest Only option or a 3/1 ARM with a 10-year Interest Only option
and still many more variations.
Example:
Here is an example of a 30-year Fixed Jumbo Loan with a 10/20 Interest Only
Option: A $500,000 loan at 6% APR has a fully amortized monthly payment of
$2998 which pays off the loan in 30 years. The Interest Only payment of
$2500 is $498 lower per month. If you only paid $2500 each month for 10
years without paying down any principal, the fully amortized payment would
adjust to $3582 in order to pay off the loan in the remaining 20 years.
Some people put the savings in payment towards common investments like
stocks, bonds or mutual funds, hoping to earn money on the payments that
they would have normally paid towards principal. People using this strategy
on a primary residence would need to earn a higher rate of return than the
interest that is being charged on the loan to stay ahead. This is because
they would not be paying down the loan and their capital gains on the other
investment may be taxed on withdrawal, so they would realize much less
profit. Not to mention if they took a ‘loss’ on that investment, they would
be paying more interest on their loan AND realizing a loss of their diverted
investment capital.
Another important distinction is if they chose not to pay any principal or
failed to invest the payment savings successfully when the Interest Only
option period expired. Their payment would greatly increase unless they
refinanced the loan at the prevailing future interest rates. In addition,
having a higher loan to value ratio makes it more challenging to refinance.
Remember that the Interest Only option is just that, an option, and can be
treated that way, only making the lower payments in times of hardship. A
nice feature if it doesn’t come at considerable added cost. Experienced
investors can also leverage the lower payments to improve earnings. In
summary Interest Only loans are all about cash flow, and flexibility. The
new available fixed rate terms give them a welcome predictability, making it
even easier for more people to qualify for a loan and own their very own
home. Now you are "in the know".
Tony Baricevic is a Senior Loan Officer with Amerimac First Mortgage in Los
Gatos, CA. His focus is on objective loan education and information. For a
copy of The Top 10 Mistakes when Buying/Refinancing a Home go to
http://www.2myeasyloan.com or call (408) 269-3279
* Negative Amortization is when a loan calculates a payment on a low fixed
rate but uses an adjusting indexed rate to calculate the interest due. If
this adjusting indexed rate payment is higher than the fixed payment, the
extra interest is added on to the principal loan balance.
© 2004 DebtConslidationDepot.com