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How does an interest only loan work?
Over the past couple of year interest loans have become immensely popular due to the lower monthly payments. In some cases such as as skyrocketing home prices on the east coast and west coast have forced buyers to get interest only loans just to qualify for the mortgage payment.
Interest only loan programs are offered on fixed rate mortgages, adjustable rate mortgages, or on negative amortization mortgages. The biggest misconception is that borrowers on an interest only loan are given the option to pay "interest only" where the borrower pays only the interest portion of the monthly payment for a fixed period. At the end of that period your loan becomes fully amortized.
With most interest only loans, you can pay as much over the interest only payment each month as you would like. Anything that is applied above and beyond the interest only payment each month will be applied directly towards the principle balance of your loan. Interest only loans provide borrowers with some extra flexibility with their finances each month by providing borrowers with a very low monthly payment.
A new program that is gaining in popularity is the 10/30 Interest Only mortgage. This mortgage has a interest only period of 10 years, after which it switches the a standard 30 year fully amortized mortgage. This loan combines the flexibility of low monthly payments with the security of a long term fixed rate mortgage.
Choosing a loan with an interest only option will usually add .25% - .50% to the interest rate.
Consult with a licensed loan officer to determine if interest-only loan is a right loan for you. Compare the payments on the interest-only loan against other alternatives such as the loans with longer amortization periods such as 40 or 45 years.
This difference in savings from making principle payments can be used for other things like paying off consumer debt or unforeseen expenses such as medical bills or a loss of income.
Interest Only loans should not be confused with negative amortization mortgages, as there is no way to increase your principle balance provided you make your payments on time every month.
Although you aren't required to pay down the balance of your loan with an interest only loan, you still have that option. You can choose to pay more each month if you would like to pay the loan off faster. A competent loan officer should be able to tell you how much extra to pay each month in order to pay off the loan by a certain time. You can choose to pay any amount that is greater than the interest payment.
Interest only loans work by giving the borrower the option of just paying the interest accrued over the month instead of the principal also. Borrowers should understand that even though their payment is lower for the interest only period they will be paying in total more over the life of the loan.
Interest only loans allow the borrower to pay only the interest accrued for an initial period. After the initial period the payments are increased to amortize the loan. The low initial payments on interest only loans can allow borrowers to qualify for larger or more expensive homes.
Interest only mortgages are often attacked because the borrower is not paying down the principal on their loan, but they should be examined in light of a borrower's specific situation.
Interest-Only loans are ideal for homebuyers who expect to have higher income and those who expect a windfall in the near future, such as inheritance or term savings account coming due. Interest Only mortgages are for those with a solid plan to get out of the loan or pay down the balance.
How an interest only loan works for you may be different from how interest only loans are perceived in the media. A common misconception: You are not limited to paying just the interest on the loan each month. In fact, you are limited to paying no less than the interest due each month, and can in fact pay more to reduce the principal whenever you feel like it.
» DISCLAIMER: The information contained in this article on 'How does an interest only loan work?' is a collection of contributions by licensed mortgage professionals and is not the opinion of Broker Outpost LLC. Always consult a licensed professional before applying for a mortgage.
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