Interest Only Loans

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Interest only mortgages are just as they sound. You only pay the interest and none of your mortgage payment goes to pay down the principal or balance.

If you start out with a $150,000 interest only mortgage and you make all your payments, you will end up still owing $150,000 at the end of the interest only period.

Companies who constantly peddled the interest only mortgage are now a being revealed as contributing to the mortgage
crisis and the rise in foreclosures.

Interest Only Loans - Are They Smart?

I don’t think so.

But it depends on the market.  If home values are flat or dropping, then I would say, “Absolutely not!”  And even if the market is headed up, I would still be leery.

Interest only mortgages sacrifice principal reduction in favor of a smaller payment. As the name suggests, a borrower only pays interest with each monthly payment.

It is fairly understandable how easy this would be to sell and sell it they did. TV commercials ran non-stop with borrowers who saved “$6,000 a year” just switching to an interest only mortgage. I can remember toward the end of the refinance boom, this type of pitch was the only way for lenders to keep up their application volume.

So what’s wrong with saving $6,000 a year, you ask?

It comes at a price. What the TV ads and interest only loan sellers neglected to mention was the risk involved…the fine print if you will.

You see…this loan took many folks out of a safe fixed rate 30 year loan and replaced it with an adjustable rate mortgage or ARM.

Interest only mortgages at the time were also an adjustable rate mortgage. Of course, if they put that little tidbit in the ads, the phones wouldn’t ring.

We all know how ARMs, once they recast to a higher rate and payment, can throw an unprepared home owner into foreclosure rather easily. Many of the current foreclosure home owners fell victim to an interest only mortgage once the initial fixed rate and the “interest only” period ended simultaneously, hitting the homeowner with a huge payment increase.

And in a recent article about a report from Fitch Ratings they say a gigantic amount of these are headed our way.

“The payment increases will be driven by changes in interest rates, expiration of interest-only periods and loan modification rate resets. And those payment increases will lead to higher default rates, Fitch said in its report.

“Default risk rises with the magnitude of a payment increase,” Fitch said. “Fitch Ratings estimates that loans with the largest future payment increases are roughly three times more likely to default than comparable loans with no payment increase.”

At particular risk are interest-only loans originated at the height of the mortgage boom. “Interest-only loans face large payment increases as their IO periods come to an end and amortization begins,” Fitch said in its report.

“As a significant number of peak-vintage 10-year IOs approach their recast over the next three years, the addition of principal will more than double the total monthly payment of many loans,” Fitch’s report continued. “A unique blend of low interest rates and shorter amortization terms has produced historically high IO payment increases.””

This recasting interest only mortgage “double whammy” simply made previously affordable homes unaffordable. Add that many folks saw their home lose value to the point they could not refinance their way out of the mess, a foreclosure was a foregone conclusion.

And they also go on to say a jumbo mortgages have the most risk in this tsunami like wave on it’s way. More than half of jumbos are interest only and ARMs.

Interest Only Calculation and Payment

To find out what your interest only payment would be you don’t need a special calculator.  Simply take your mortgage balance and multiply it by the interest rate.  Then divide by 12…that is an interest only payment.

If you would like to use our principal and interest calculator, just click on our mortgage calculators link.

Remember, interest-only is what we call a payment option. The fact a loan may be interest-only doesn’t effect the type of loan, only the way it is paid.

Let’s look at the difference between an interest only payment and a fully amortized payment. These are just examples on the rates. Each person’s rate depends on many different factors…more below.

And here is what the balance of your mortgage would be after 3 years.

Interest Only Mortgage Rates

So, if you are considering an interest only mortgage, you must look at ALL the terms…not just payment.

That said, when considering “interest-only” payment loans two common practices are utilized.

One, interest-only payment terms are typically only offered on adjustable rate loan programs. So, 3/1, 5/1, 7/1, and 10/1 ARMs were the only programs that would offer an interest-only payment option. That fact gets hidden in most advertising of “interest-only” mortgages.

The “interest-only” payment option comes with a cost…rate bump if you will for the luxury of paying only the interest. So the rate is higher than a standard fully amortized mortgage payment.

But there are also other adjustments for things like credit score, loan to value, etc. that affect rates. The rate for interest only will be different for each person depending on your financial picture. For more information on these adjustments click on the link.

There are other reasons to avoid these payment types, the number one reason…

You never pay off the loan!

What’s the point of buying a house, if you never actually own it?

Good Luck!

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Interest Only Loans was last modified: April 8th, 2020 by The Mortgage Insider
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