Interest only Mortgages

Why I like Interest Only Mortgages

You may have heard pundits on financial shows or in the paper or magazines warning against those horrible, ruin your finances, force you into foreclosure, interest only mortgages! Well, some of them are confusing them with negative amortization mortgages, some think you are not bright enough to manage a 3 or 5 year ARM, and still others think that you just simply lose if you are not forced to pay anything against principal.

First of all when considering a mortgage you need to look at a time horizon between 3 and 10 years. Why? Because that is when your current circumstances are most likely to change either intentionally or unintentionally. Market conditions may change and rates will either go up or down. You may progress up the corporate ladder and upgrade to a larger home or, get transferred. The kids may be approaching College age and you may want to pull some equity out of your home for tuition expenses or, get my drift.

You can get an interest only mortgage for 3,5, or 7 years after which it converts to an amortized 1 year ARM but, my favorite is the 30 year fixed, that is a fixed interest only rate for 10 years and then converts to a 20 year amortization and if your credit score is high enough, some lenders will let you have the option of converting at the original rate or the market rate 10 years later, whichever is lower.

O.K. as I always say, the numbers don’t lie. So let’s get to them shall we? Our loan amount is $175,000 and our interest rate is 6.5%. The amortized payment is $1,106 and the interest only payment is $948.00( both rounded ) a difference of $158.00. Now what to do with the difference? Your amortized loan will reduce you principal balance by $11,181.00 over 5 years. If you took your $158/month and invested it at 5% APY you would have $11,000.00 over 5 years but, it would be LIQUID! To get your equity out you would have to pay the cost of refinancing (rolled in or not) and you would be subjected to current rates, may be good, and may be bad. If you got an equity line, your costs would be reduced but it would cost you every month for your money!

Let’s say you didn’t want to do that. Let’s say you just paid that $158 every month against the principal. At the end of 5 years you would reduce your balance by $9,480.00 AND you would lower your payment to $896.00! The beauty of a simple interest loan! Lower the principal balance, lower the payment!

Flexibility and options in a mortgage, what will you choose.