Welcome back! Before you read any further, I encourage you to read about Adjustable Mortgages here: http://homebuyingguru.blogspot.com/2013/09/affordable-non-traditional-mortgage.html Interest only loans often are adjustable loans so it is good to fully understand an adjustable mortgage before you go on to read about interest only options.
I find that often, clients will confuse an interest only loan with what is called a "Negative Amortization" loan. This was most commonly called the "Pay Option" loan or the "Pick-a-pay" loan. With this loan you had four payment options, one that was a 15 year loan payment, a 30 year loan payment, an interest only payment and a "Minimum Payment." The minimum payment in a pay option loan would actually increase your balance every month because you were actually paying less than the monthly interest. For example, if your interest only payment was $1,000 and your minimum payment was $600, the bank isn't going to just hand you that extra $400 in interest for free. So, it gets tacked on to the balance of the loan. A regular interest only loan DOES NOT DO THIS.
Now that we clarified that, let me explain that what a typical interest only loan is. Let's start with a standard fixed rate interest only loan. Most people know what a 30 year fixed loan is, but let me explain to make sure. Most home loans have either 15 or 30 year term. That means if your loan is fixed for 30 years, you have the same rate the whole 30 years of the loan and typically the same payment. However, a 30 year fixed interest only loan usually will not have the same payment for the life of the loan as the interest only feature is only offered for a maximum of 10 years.
Let's look at some numbers to explain. Take a $200,000 30 year fixed loan at 4.625%. Traditionally the mortgage payment for this loan will be $1,028.28 for 360 months (30 years). With the interest only option, if the rate is the same, you can pay as little as $770.83 per month for the first 10 years. After that, it "Recasts" meaning whatever your balance is at that time determines what your payment is over the remaining 20 years. So, if you don't refinance and you have made only the interest only payment during that period, you essentially have a 20 year fixed loan at that point at a rate of 4.625%. That would mean your payment would be $1,278.83 for the remaining 240 months.
The advantage of this option is that typically people will be making more money in ten years than they are currently. So, they exchange the comfort ability of the lower payment now, for the higher payment later but still retain a fixed loan and pay their house off in 30 years. However, people rarely keep a loan longer than 10 years. Typically they move or refinance during that period so often I encourage the 10/1 ARM Interest Only loan as it will usually have a lower rate than the 30 year fixed. There is also a 5/1 ARM Interest Only option as well as a 7/1 ARM Interest only option. (If this doesn't make sense to you, I encourage you to read the article I linked at the top of the page or contact me).
The advantage of the 10/1 ARM Interest Only loan is that the rate adjusts at the same time you loose the interest only feature. Typically this is when people will refinance anyway because many don't want to pay the 20 year payment even if the loan was fixed. As explained in the previous article, it is possible that your payment may even drop with the adjustable mortgage as well.
I hope this helps to clarify this loan option. If you would like to know more, please contact me at 1-866-777-1865 or email me at shawnkrumpe@gmail.com. You can check me out more at www.financehomestoday.com.
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