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[H922]How To Calculate Interest Only

by Nazir Hussain, Naz

For example, if you borrow $100,000 to buy a property. Your mortgage is for a 20 year period. As an interest only mortgage, assuming an interest rate of 5% ? your yearly interest charge on this amount is $5,000. Amortize that over 12 months; your monthly outgoing under the interest only scheme is $416.67.

Your total interest payments for the duration of the mortgage = $100,000.80 At the end of the mortgage period, you still owe the lender the original amount of money which you borrowed. Therefore, what appeared to be an attractive proposition at the outset does not look so good when you do the maths. This is the major draw back with interest only mortgages.

For the purposes of a comparison, consider the same amount of borrowing on a repayment basis:-

Assuming a borrowing of $100,000 over a 20 year period at an interest rate of 5%. Your initial monthly outgoings will be 2x$416.67 per month. Repayment scenario is much more expensive it would appear but you are reducing your capital slowly on a sliding scale. Your last monthly instalment gives you complete ownership of the property in question. Whereas the cheaper of the two mortgage options namely the interest only mortgage leaves you with a liability of $100,000 at the end of your mortgage term. This money has to be repaid as a lump sum to remove the legal charge by the lender which provides his security.

So, what kind of borrower should consider the interest only route?

Clearly, interest only route offers better prospects for short term borrowing. Plus, interest only route gives you access to more borrowing. Therefore, the kind of borrower that this mortgage suits is a developer rather than long term investor like a home buyer with a 20 year borrowing term as illustrated in this case scenario.

Information in the public domain suggests a preference for repayment mortgage over the cheaper alternative that is interest only mortgage. We decided to put that conclusion to a test by conducting a small survey.

1)Payment for a interest only mortgage is $416.67 per month.
2)Payment for a repayment mortgage is double that amount at $833.34 per month.

10 out of 10 people chose the interest only mortgage as their chosen mortgage. However, when we explained the implications of each mortgage in detail. 8 out of 10 people changed their original preference to the repayment one because repayment option offered them greater certainly in the long run. The remaining 2 people were asked why they chose to stick with their choice? Their response was that interest only mortgage offers us more leverage in the short term and it therefore suits our investment criteria.

Finally, home ownership is very long term commitment. Therefore, weighing up all the possibilities is very important. Such a strategy enables you to make your decision with all your information and options to hand. Better decisions are based on good and clear information.

Interest only mortgages allow borrowers to reduce their monthly repayments by only paying interest on the outstanding loan balance. Capital repayments are not made on a monthly basis with this type of home loan product. Instead, the payment of the capital portion of an interest only mortgage is deferred until the end of the term of the loan.

Because interest only mortgages reduce the amount of the payments due to the lender each month, they are a popular vehicle for individuals to finance the purchase of their first home.

This type of mortgage product can help ease the financial burden involved with home ownership, allowing borrowers to get a foot on the property ladder and switch to a repayment mortgage when it becomes more affordable. In order to make it more affordable the borrower will need to make payments to the capital portion of their home loan in order to reduce the base from which interest is calculated.

Interest only mortgages are therefore a short-term solution to the high cost involved in borrowing money to acquire property. While interest only home loans are popular at all times, they become even more popular during times of high interest rates.

Despite the advantage of reducing the amount of each monthly mortgage payment during the term of the loan, this type of products does have a large disadvantage in that they leave the borrower with a large balance to repay at the end of the term.

To ensure this does not happen, the borrower should either switch to a repayment mortgage at some point during its term of the loan, or set up a Capital Repayment Vehicle (CRV).

A Capital Repayment Vehicle is an investment policy designed to produce enough money to repay the balance of the mortgage at the end of its term. CRVs are usually found in the form of an endowment policy, an ISA-based investment scheme, or a personal pension plan.

Regardless of how the borrower is planning on repaying the capital portion of the loan, a level term assurance policy should be taken out when the interest only mortgage is established. A level term assurance policy will pay out a fixed sum upon death of the assured. The amount assured should cover the capital portion of the mortgage.

Because of the risks involved, borrowers should consult an independent financial adviser before applying for an interest only mortgage to ensure that the right product is selected to suit their personal financial situation.

Applications should also keep in mind that this type of home loan should be used as a short term solution to getting on the property ladder or reducing their monthly repayment amount. An interest only mortgage should not be held over the long term as the balance of the loan will need to be repaid at some point in the future and lenders may not allow borrowers to remortgage past a certain age.

Careful consideration should therefore be given as to whether an interest only mortgage product is an appropriate product to apply for.

Article Source : 15 Year Fixed Mortgage

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Both Nazir Hussain & Michael Sterios 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.

Nazir Hussain has sinced written about articles on various topics from Debts Loans, Investments and Debts Loans. Interest only mortgage is another way to finance your home purchase. Nazir's advise to any long term investor is go for a repayment or similar product. For more info. check out. Nazir Hussain's top article generates over 550000 views. to your Favourites.

Michael Sterios has sinced written about articles on various topics from Internet Marketing, Adverse Credit and Home Improvement. For advice on , information on various types of ,. Michael Sterios's top article generates over 165000 views. to your Favourites.