Interest-only Mortgage FAQ
An "interest only" mortgage can be a great solution for buying real estate. If you are considering an "interest only" mortgage, then you should be aware of the facts before you sign on the dotted line. Although these types of mortgages lower your monthly payments, you can get yourself in financial trouble if you are not careful. Understanding the different "interest only" loan options available as well as the pros and cons of having one is very important.
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Interest Only Adjustable Rate Loans
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An interest only adjustable rate typically has the lowest payment option because of its smaller initial fixed rate period, during which the rate will not change. It is important to understand that when this period ends the rate can fluctuate. The adjusting rate is tied to an index, such as the LIBOR (London Interbank Offered Rate), the COFI (Cost of Funds Index) or the CMT (Constant Maturity Treasury). The rates are configured by adding one of these indexes to a margin figured by the bank. A margin is the percentage points the bank and the customer have agreed upon in the loan. Fortunately, there is usually a cap on the interest rate, which prevents it from going too high.
Interest Only Fixed Rates
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These loans usually have full amortizing fixed rates. They can have terms of 10, 15, 20 or 30 years. An interest only fixed rate mortgage that is amortized over 30 years permits the borrower to pay interest only for the initial interest-only period of 10 or 15 years. Once the period ends, the borrower is responsible for both the interest and the principal.
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Advantages of Interest Only Loans
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One major advantage of having an interest only loan is that it makes it possible for more people to get into homes because of lower payments. When you have an interest only loan, you are only responsible for paying the interest portion for a set amount of years, typically five, 10 or 15. After that you are responsible for both the interest and principal in your payments for the last few years of the loan.
Interest only loans can help borrowers purchase more house then they would have been approved for with a traditional loan, and they are beneficial to consumers wanting to purchase investments, rental properties and land for a short period of time, then turn around and sell them for profit.
Disadvantages of Interest Only Loans
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When principal is not getting paid down, the loan amount stays the same and there is always a chance of negative equity. In other words the home could be worth less then the loan, making it harder to refinance or sell if desired. Also, when the interest only period ends and homeowners are required to start paying towards the principal, payments might not be manageable. Because many consumers desire a home more expensive then what they can really afford, the end of the interest only period can be quite a shock.
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References
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