Interest
Only Mortgage
An Interest Only mortgage allows you to pay only the interest instead of the
interest and principal on your mortgage each month.
Remember, the lower payments do not last forever! At the end of the Interest
Only period, principal and interest paymetns will begin at an amount necessary
to pay off the loan.
Typically, interest only payments on a 30 year mortgage and a 3 year ARM are
for 10 years. A 5 year ARM will have 5 years of interest only and a 7 year ARM
will have 7 years of interest only payments.
Advantages of an Interest Only Mortgage
- Lower initial payments mean you can qualify for a higher priced home
- The entire amount of your mortgage payments are a deduction on your taxes
- When home prices are rising, equity builds up without paying principal
- If principal money is put into investments, you can leverage your money
wisely
Disdvantages of an Interest Only Mortgage
- Higher payments during principal and interest period make up for the interest
only period
- When home prices are falling, you could owe more than the home is worth
- Balance of mortgage remains the same
Example
Using a mortgage for $150,000 on a 30 year fixed mortgage here is how it would
work and you can use the interest only payments to your advantage.
| Loan Term |
Rate |
Monthly Payment
first ten years |
Monthly Payment
last 20 years |
Total Payments |
30 year
interest only |
6.00% |
750.00 |
1,074.65 |
347,916.00 |
30 year
fixed rate |
6.00% |
899.33 |
899.33 |
323,757.28 |
| Interest
Cost over 30 years $24,158.72 |
Use the extra money to invest
Everyone has seen those charts the investment firms show that tell you how much
money you would have in 10 years if you just put away $150 a month, right? Well,
here is a great way to do just that.
Did you know that if you invest $150 per month for ten years (a total of $18,000)
that it would be worth $27,441.91 at the end of the 10 years? (assuming an 8%
return on your investment).
Carrying this example further, if you never put another penny in the account,
it would be worth $59,245.03 after 20 years, $87,050.38 after 25 years and $127,905.57
after 30 years.
If you continued to put that $150 per month in the account, now that you are
used to it, the balance in the account would be $223,553.92 at the end of the
30 years.
I often suggest to borrowers that can afford it that an interest only mortgage
may be a great way to invest for their retirement. True, your house payment
will be higher in 10 years, but that is really like refinancing into a 20 year
mortgage.
This could be a way to create a forced savings if you are the kind that just
never seems to put some away for a rainy day and you could have a nice retirement
account when it is time to sit back and relax.
You can use the savings calculator at
CNN
Money to figure out savings for yourself.
How this Leverages your Money
By deferring the payments on principal for the first ten years and investing
that money you are creating an extra $18,000 in an investment fund.
As we noted, that $18,000 costs you about $24,000 over the 30 years. However,
that additional interest is not paid until 10 yeras down the road.
Not a bad deal when you look at the fact that this money is worth almost $128,000
at the end of the 30 years. That's right, in return for $128,000! Now THAT is
leveraging your money.
This is how the big investors make their money, they use it in 2 places at once.
Shouldn't you?
Summary
An Interest Only mortgage is a great way to either get the house you really
want or to help put away some savings, but this mortgage is more expensive in
the long run that a conventional 30 year fixed rate mortgage.
With a good plan that you follow, this can be a great option. If you do not
follow a plan, this is a more expensive option even though it looks cheaper
in the short run.
If you are only in the mortgage for a short time and home prices are rising
(1 to 5 years), the money you would put towards the higher payments can definitely
put to better use in other places.
As long as home prices are rising in your area, you will not get into trouble
and over the last 30 years, areas with falling prices are few and far between.
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please contact me by email at scott @ dailyinterest.com
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