What Is Interest Only?

An Alternative Mortgage Structure for Borrowers with Interest-Only

If the borrower plans to make the higher payments after the introductory period, that's how it works. Some people increase their income before the introductory period ends. Others plan to sell the home.

If interest rates rise, the remaining borrowers will not be able to get a new interest-only loan. The second advantage is that a borrowers can pay off their mortgage quicker than a conventional loan. Extra payments are made to the principal of the loans.

The lower principal on the interest-only loan makes a slightly lower monthly payment. The monthly payment is the same in a conventional loan. The benefit of paying off the loan quicker is that borrowers don't realize it until the end of the loan period.

Interest-only loans are dangerous for borrowers who don't know the loan will convert. They can't afford the higher payment when the rate is not renewed. If they sell the home, they will get nothing, because they haven't got any equity.

The second disadvantage is that people are counting on a new job to pay more. The higher the amount, the worse it is. If interest rates rise, others can't afford to refi.

Interest-Only Mortgages

There are different ways interest-only mortgages can be structured. Interest-only payments may be made for a specified time period, or they may be given as an option. Some lenders may only allow for paying the interest exclusively for certain borrowers.

Special provisions may be included in some interest-only mortgages. If damage occurs to the home, a person may be able to pay only the interest portion of their loan, but they have to make a high maintenance payment. The borrowers may have to pay interest only for the entire term of the loan, which requires them to manage accordingly for a one-time lump sum payment.

A Real Estate Investment Loan with a High Interest Rate

The other main advantage is that you can use your cash flow to make more investments, add capital value to your real estate, or pay off higher interest debts. The bank was happy to extend their IO term and refinance their investment loan by using their offset account and paying extra into their investment loan, which is a higher interest debt than a standard home loan. If you are regular with your payments, most lenders will allow you to extend the interest only term by another 5 years. A few lenders may consider extending the period by 10 years.

An ARM Loan with Interest

If you get an ARM loan, your payment would work as follows. The monthly charge includes both principal and interest. You pay back some of the money you owe.

The interest charges are the cost of doing business for receiving a loan. The payment is still lower since you receive a lower interest rate for an ARM loan. The monthly payment is $1,266.71 for the example, which allows for some variation for tax adjustments.

If your rate is 3 percent for the first five years, you will pay $1,054.01. That sounds great, but you can do better. Interest-only loans behave differently.

The lender doesn't expect you to direct a portion of your payment towards the principal. You can do so and should if you choose, but there is no cost of doing business if you decline to do so. The pre-adjustment phase of your loan requires you to make associated payments to remain current with your interest.

The consumer would only be charged $668.89 for the first five years of their loan if they used the same parameters for monthly payments. You can still see the advantage, even though there would be no payment toward the principal. The loan costs are less each month.