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Interest-Only with Extra Mortgage Payments Calculator

One problem with interest-only loans is that unless home prices rise the homeowner does not build any equity in their house, which puts them in a precarious position when mortgage rates rise. One way to build a bit of a buffer from market fluctuations is by adding extra payments applied toward your principal.

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Making Extra Mortgage Payments on an Interest-Only Loan

Interest-only loans offer a flexible financing option for those who need to reduce their monthly mortgage payment. Just like the name says, you only pay the interest on the loan, rather than the principle. As a result, you lower your payment as much as you possibly can.

For example, if you have a $200,000 loan with a 4.5 percent interest rate, you will pay $750 a month with an interest-only loan. With a conventional 30-year, fixed-rate mortgage with the same interest rate, you would pay $1,073.64 per month. With the interest-only loan, you save yourself hundreds of dollars per month.

People choose interest-only loans for a number of reasons. Some people may choose them in the beginning so they can afford a larger house before they start making more money at work or get the big promotion they were expecting. Others may choose them because they plan to flip the home for a profit within a relatively short time, and they don’t want to spend more money than they have to before the sale.

The primary drawback of an interest-only loan is that you don’t build any equity while you are paying it. In some cases, you may even develop a negative amortization, not paying the full interest on the loan in pursuit of paying even lower monthly payments. At the end of the loan term, you would owe more than when you started it.

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By making an extra payment toward your mortgage each month, you can help to pay down your principle, helping to create a buffer against fluctuating mortgage prices. That way, when you are ready to sell, you aren’t taking as big a risk in case your home does not appreciate as much in value as you originally anticipated.

The difference between making extra payments and making a traditional mortgage payment is that you choose how much you pay, and you can change the amount each month if you choose to do so. Whatever amount you pay can help you pay down the balance, and you can decide the amount based on your current financial circumstances.

Even small amounts can make a big difference. For example, if you make an additional $50 payment per month on that $200,000 interest-only loan with a 4.5 percent interest rate, you will reduce the amount of interest you pay by $12,116.25 over the life of the loan, and you will gain $18,000 in equity. That’s assuming that you make the $50 a month payment consistently and that you do not have an interest-only loan with a variable rate.

Even one-time payments can help you pay down your loan balance, since they go directly to the principle of the loan. Tax refunds, investment dividends, insurance payments and annual work bonuses can all be diverted to your mortgage to help you pay down the balance faster. Though it may not be necessary, it can help you to build more equity in your home in case of fluctuations in the housing market. If the value of your home drops, you can protect yourself against losing money. If your house appreciates in value, you can make an additional profit.

 

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