|Interest-Only Loan Payment :||$989.58|
|Total Interest-Only :||$356,250.00|
|Monthly Principal & Interests :||$1,342.05|
|Total Principal & Interest :||$483,139.46|
When applying for a mortgage loan for your home, you can choose between a standard loan and an interest only loan. With an interest only loan, you will pay only on the interest when you make your monthly payments and you will eventually be called upon to pay the principal. It is a wise financial decision to compare the two types of loans before deciding which one is best for you.
If you wanted to borrow $250,000.00 for the purchase of your home, you might be offered a standard loan with a 5.000% interest rate or an interest only loan with a 4.750% interest rate, with both being 30 year loans. With an interest only loan, your monthly payment would be $989.58, while a standard loan would be $1,342.05. Under this plan, the total interest only cost would be $356,250.00, while the total standard loan cost would be $483,139.46.
Paying an Interest-Only Mortgage
A 30-year, fixed-rate mortgage is the traditional loan choice for most homebuyers. However, the loan is inflexible, and it may not offer every buyer the options they need to meet their financial goals. For example, some home buyers may not have the down payment or other financial credentials they need to get the 30-year mortgage for the home they want to buy. Other home buyers may want to free up cash to invest in other opportunities while still taking advantage of a hot real estate market. In these and other instance, an interest-only mortgage may be the right option.
There are Some Advantages
The attraction of an interest-only loan is that it significantly lowers your monthly mortgage payment. Using our above estimator, on a $250,000 house with a 4.75 percent interest-only rate, you can expect to pay $989.58, compared to $1,342.05 for a conventional 30-year, fixed-rate loan at 5 percent interest.
Investors often choose an interest-only loan as a way to keep their expenses low while they renovate or market a home for resale. The strategy is a smart one in a hot housing market where prices are appreciating fast and investors can plan to make a fast resale for a profit.
Those interested in investing may also choose an interest-only loan so they can put their money toward higher-yield investments.
Homeowners who can’t quite afford the home of their dreams but who expect to increase their earnings potential in a few years’ time may also find an interest-only loan to be the solution they need. For example, if a couple expects one partner to return to the workforce after caring for children or to receive a big promotion, they can get an interest-only loan at the start of their mortgage, then transition to a traditional loan when their financial situation improves. They can then purchase the home of their dreams without having to wait for their financial situation to adjust.
Risks of an Interest-Only Loan
There are many risks associated with interest-only home loans, so it is important to carefully consider all the options before choosing one.
Because you are only paying interest, you are not repaying principal to build equity. If you are trying to sell your home before the loan comes to term, you are betting on the value of your home appreciating in a very short time. If you lose that bet, you could end up owing a lot more money – or losing money in a sale. To minimize that risk and build equity one can periodically make extra payments.
Interest-only loans typically last for a term of five or 10 years. Within that time, the interest rate may adjust as often as monthly. If that’s the case, you could end up paying much more than you bargained for when you took out the loan. At the end of the loan, you have to either get another interest-only loan, or you have to get a conventional loan. Since you have built no equity up to that point, you can expect to have a significantly increased payment as you try to catch up on the principle.
In some cases, you may get negative amortization with an interest-only loan. That means that you aren’t even paying the full interest on the loan, so when the loan comes to term, you will have a higher balance than when you started paying it.
Calculating the Risk
By understanding all the risks and benefits associated with interest-only loans, you are in a good position to make the right decision for your family. You can use the above calculator to help you determine what kind of payments you can expect with an interest-only loan compared with a traditional mortgage, then use that information for educated financial planning.
You can use this tool to compare interest only mortgages to fully amortizing adjustable rate and fixed-rate mortgages.
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