An interest only loan just as the name suggests is a mortgage which does not reduce the principal loan amount. This loan only reduces the monthly installments covering the interest of the loan. This implies that the borrower will always owe the same amount as you will only be paying the interest. These loans are rare compared to the others as they are not for everyone. Florida Mortgage Pros sheds more light on the interest-only mortgage loan. The purchased property typically secures the loans. There is an option of always paying more than the interest, but it is seldom taken. This loan is popular to many people as it significantly lowers the installments made monthly on the mortgage. However, the loan is also infamous due to its high risk. When used correctly under the right scenarios, the loan can be highly beneficial.
How the Loan Works
The primary loan amount is excluded when the monthly installments are calculated, and only the interest on the loan will be required to be paid every month. To clarify this, if a borrower takes an initial loan of $100,000, which has a 6.5% interest repaid over 30 years, this will result in a monthly repayment of $627. This includes both the interest and principle. The exciting part of the loan amount is $541.50. This means that there would be a monthly saving of $85 when a borrower takes an interest-only loan.
Different Types of Interest Only Mortgages
Most of the mortgage types providing the interest-only option lack an unlimited term. This implies that you cannot continue paying for the interest forever. After a certain period, the principal loan will be fully repaid over the remaining loan term. For instance, a 5/20 mortgage will allow for interest-only payments for the initial five years of the 25-year term. After that, the initial loan amount will be repaid over the remaining 20 years of the original term when both the principal amount and interest will form a section of the monthly repayment. For example, with a 30-year mortgage with an option of paying only 6.5% interest for the first five years on the primary loan amount of $200,000, this will result in monthly repayments of $1,083 for the first five years and $1264 for the remaining twenty-five years of the loan term.
How to Calculate an Interest Only Payment
Step 1: Multiply the interest rate by the principal loan amount. In the example given above, for example, this would be $200,000 multiplied by 6.5% giving an annual interest of $13,000.
Step 2: Divide the resulting annual interest by 12 months to get the $1083 amount.
How You Can Benefit
This type of loan is for first-time home buyers. This is because many new home buyers lack the needed income to afford to repay a conventional mortgage, therefore, preferring renting rather than buying.
The monthly interest only repayments give the homeowners financial flexibility to unforeseen circumstances. This means that homeowners can pay the monthly interest when they can and can pass during emergency times or times of financial difficulty.
This loan also benefits the commission earners and the self-employed individuals not earning a stable monthly income. During their high times, borrowers can pay more towards the principal amount and pay for the mortgage interest during the low-income months.
This loan type is a bit more expensive compared to the other traditional mortgage types due to the higher risk that lenders face. In most cases, the difference is normally as low as 0.5% in the charged interest on the principal amount. Extra fees can also apply depending on certain circumstances.
Misconceptions and Real Risks
One of the misconceptions is that the balanced owed to the mortgage does not increase as in ARM loans. Increasing the balance is known as negative repayment and does not apply to the interest-only mortgages. The main risk is when selling a property that has not increased in value. Due to paying interest only, the principal amount will not have reduced, and consequently, the loan amount will not have changed. This implies that the full amount will become due, and the homeowners will run at a loss.
This is a risk that is also run when taking out the traditional mortgage. Rarely can loans cover the costs of selling a property which has not increased in value. A substantial down-payment will lessen the risk factor on this type of loan.
A dip in the property market can lead to equity loss on the property. However, this risk linked to a drop in the property market is faced by all homeowners going for mortgage loans. Before making your final decision, consult Florida Home Pro experts to help you determine your ideal option.