Interest-Only or ?Interest-First? mortgages have been around for quite some time now, but have recently been exploding in popularity. Originally offered primarily in the non-prime market, interest only mortgages are now available as conforming loans and can come as a feature on a wealth of loan programs, including adjustable rate mortgages, 40 and 50 year term loans, stated income loans, and to borrowers with credit scores as low as 540.
The first thing you should know about an interest-only mortgage loan before you commit is that YOUR PAYMENT WILL CHANGE. (read, YOUR PAYMENT WILL INCREASE). With an interest-only loan, your first payments are towards the interest, not the principal. After a set amount of time (traditionally, anywhere from two to fifteen years), the lender will require you to start paying back the principal along with your interest payments. As long as you are prepared for this payment adjustment, interest-only loans can be an extremely useful tool in financing, especially purchases. With a lower monthly payment, your purchase power increases when shopping for your dream home, and you can always re-finance down the road to a regular amortizing loan.
There are a few caveats to be watchful of. Some predatory lenders target first time homebuyers by telling them they can afford (on paper) that gorgeous seven bedroom mansion. The mortgage they may have in mind could have a fixed rate for only two years (and then increase 2-3%), be interest only for the first two to five years, and have a pre-payment penalty that would cost them thousands of dollars if they want to refinance or even sell in the first two to five years of the loan. Unable to cope with the payment shock, the new homeowners may be forced into a very uncomfortable financial position.
Interest-only mortgages are a viable for many people. Just make sure you do your research and understand all facets of the loan you are offered.
You can't blame people for choosing the 'lowest' cost option, can you?
So how does an interest only mortgage work (I've had many clients call it an interest free mortgage - if only!), as against the other option of a capital repayment loan?
With an interest only mortgage, you only pay back the interest on the mortgage every month. So, for example, on a ?150,000 mortgage you would cut annual payments by around ?3,000 as opposed to the repayment option.
But of course this means that you are not paying off any of your debt - the capital. And at the end of the loan term you would still owe ?150,000.
If you want to repay capital from day one of your loan, then you need to take out a repayment mortgage. This spreads the interest and repayment into one monthly payment, typically over 25 years. This then guarantees to pay off your debt.
So, lets look at costs.
For a ?150k loan at say 6% over 25 years, the difference per month would be circa ?222. So you could say that over the 25 years you have saved ?66,000 - but at this point you have to pay back the lender the ?150,000.
It is also true to say that over the term of the loan, the interest only route will mean you will actually pay more in interest.
Why?
Well, if you do not pay back any of the ?150,000 capital debt, the lender will charge you interest on the entire loan for the entire term. Whereas with a repayment mortgage, you are trying to get rid of your debt from day one and you will therefore gradually chip away at it until it's all gone - meaning the debt gets smaller which affects the amount of interest you pay overall.
On this sort of example, the interest saved would be around the ?80,000 mark.
So, ideally, we should all have a repayment mortgage.
Clearly, using the interest only route when you are struggling to cover costs as a new buyer is perfectly valid.
It is also worth mentioning that the following reasons could be part of an overall strategy that a doctor/dentist can use:
- maturing policies/pensions - pay more later re promotion/private practice building - using offset accounts and "parking" tax monies/spare cash - downsize - sell "buy to lets" in future - inheritance
All of these are perfectly valid, but do not put your head in the sand, plan, and plan well.
The Financial Tips Bottom Line:
As you can see, the interest only route has its merits, however the negatives outweigh the positives. If you have recently purchased a property with an interest only loan, make a point of reviewing it (perhaps when your deal comes to an end) and switch to a repayment mortgage when the timing is right.
Both Cl Haehl & Ray Prince are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
Cl Haehl has sinced written about articles on various topics from Unsecured Loans, Bad Credit Loans and Finances. - We maintain a list of recommended mortgage companies online and update. Cl Haehl's top article generates over 14800 views. to your Favourites.
Ray Prince has sinced written about articles on various topics from Finances, Babies and Property Guide. Ray Prince is an Independent Financial Planner with Rutherford Wilkinson plc, and helps UK Resident Doctors and Dentists get the best deals on mortgages, protection and investments, as well as helping them achieve their financial objectives. Click here fo. Ray Prince's top article generates over 33100 views. to your Favourites.